Borrowing Money

Planning on borrowing money? Make sure you have everything you need for a successful loan experience, whether you're borrowing from friends and family, from yourself, or from a financial institution.

A Grand Guide

From banks and online lenders to friends and family, there are many ways to borrow money. Your financial situation is unique, so you’ll want to get a bird’s eye view 🐦 of what it takes to borrow money and how to do it best.

Here’s everything you need to know about borrowing money, including methods of borrowing, questions to ask before you sign and commit to a loan, and more.

What we’ll cover:

How Much Money Do Americans Borrow?

Borrowing when times are tough is just a way of life.

Sharing Money Pigeon

On average, Americans borrow $9,928.62 for a personal loan, according to one survey. People borrow money for different reasons—to consolidate debt, start a business, pay medical expenses, fund renovations, help family members, and more.

These personal loans don’t always come from a bank. People also borrow money from government programs, credit unions, hard money lenders, private lenders, peer-to-peer (P2P) lending platforms, family, or even friends. While the source of a personal loan differs, one thing is clear:

Borrowing money helps people get things done. 💪🏽

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Your Borrowing Options: 5 Ways To Borrow Money

When you're in a pinch, you're probably asking yourself - where can I borrow money asap? Here are five ways to borrow money, plus what to know about each one.

Personal or Business Loans from Financial Institutions

Banks, credit unions, or online lenders can lend you money. Asking for money from these institutions often requires an application and approval process. This may be a solid option for people with good credit who won’t be burdened by super high interest rates.

Friends and Family

If you want to avoid a lender, you can borrow money from someone in your life. This lets you bypass a credit check and application process. Ensuring clear repayment terms and a firm contract will help keep the relationship between the borrower and lender solid. 🤝🏽

P2P Loans

You can borrow from a pool of institutional or individual investors. Origination fees may be high, upwards of 8% in many cases, and these loans occasionally require high credit scores and an approval process.

Payday Loans

If you need cash fast and have exhausted other options, you may use a payday loan. Expect to pay a high interest rate upwards of 391%. We recommend you make payday loans a very last resort and avoid these types of loans at all costs.

Borrowing From Yourself

For many people, borrowing money from yourself is one of the last resort options. You can borrow from your 401(k) or other retirement accounts, or take out a home equity line of credit. However, there are downsides—like tax consequences and the risk of overspending.

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Advantages and Disadvantages of Borrowing Money from Family and Friends

Every method of borrowing money comes with its own ups and downs. When taking a loan from family and friends, consider the potential downsides so you can mitigate the risks ahead of time.

Pros

  • You can score a favorable interest rate 🙌🏿 especially if you have a low credit score that would require a high-interest rate to borrow through traditional financial institutions. This is good for the lender and borrower because it means you can pay back the loan faster.
  • The loan process is more streamlined than borrowing from a bank or even a P2P platform. While you’ll still want to sign loan contract paperwork with your friend or family member, it’s a lot less hassle. Plus, there’s no official application process. Instead, you can explain your situation and the amount of money you need—in-person, on the phone, or even in a letter.

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Cons

  • When friends or family members borrow money from one another, there’s a risk of interpersonal conflict. Having a loan contract with clearly stated terms is a good workaround. Pigeon offers all the documentation you need to set—and keep—financial commitments to friends or family members.
  • If the loan isn’t properly documented, both the lender and borrower may face tax scrutiny. The Internal Revenue Service (IRS) taxes private loans and gifts differently. Avoid tax complications and have Pigeon keep track of every version of your loan contract so you can quickly refer to it when you need it.

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💡 Pro Tip: If you’re a minority starting a business, getting funding can be logistically tough. To remain a Black-owned and/or women-owned business and keep federal contracting preference or other benefits, you must retain at least 51% equity in your startup. This means you can’t exchange too much equity for funding from non-minority backers. Borrowing money from family and friends can fill that gap in capital.

Checklist: Ask Yourself These Questions Before Borrowing Money

☐ Do you trust your lender? Whether it’s an institution or an individual, make sure you choose someone reputable. Both parties in a loan agreement deserve to feel secure.

☐ Do you have a budget plan in place to repay the loan? Ensuring your capital is all set will help ease your mind as the loan repayment period begins. Be sure to account for interest payments.

☐ Do you know what the contract entails? Any promissory note or loan contract should state the amount of money you owe, the date it’s due, the interest rate, and any other loan terms you choose to include.

☐ Do you have a spending plan in place? Avoid overspending or spending your loan on something it’s not intended for.

Checklist Pigeon

Financial Terms to Know When Borrowing Money

Sound like a pro when borrowing money by knowing these terms.

Amortization Schedule

A periodic loan payment table including the principal and interest that the borrower will pay back over time.

Annual Percentage Rate (APR)

The percentage the loan charges the borrower per year (based on interest and additional charges).

Balloon Payment

A larger payment made toward the end of a loan term, especially for high-interest loans when regular payments aren’t reducing the principal.

Capacity

The borrower’s gross monthly income (lenders use this to determine the size and payment schedule of a loan).

Collateral

An item that secures a loan, such as a house or a vehicle.

Cosigner

A third party—usually a friend, family member, or significant other—who agrees to pay back the loan if the borrower does not

Guarantor

A third party who pledges that a borrower is able to repay the loan and takes responsibility if they fail to pay.

Hard Inquiry

A type of credit check that reports to the three main credit bureaus: Experian, Equifax, and TransUnion; it dings a borrower’s credit score for a few months and remains on a credit report for two years.

Interest Rate

The percentage of the loan that the borrower must pay per period as a fee to the lender.

Loan-to-value (LTV) Ratio

Percentage of the value of the collateral that’s being put up for loan (in a mortgage with a 20% down payment, the LTV ratio would be 80%).

Origination Fee

A fee, typically a percentage of the loan, that a lender requests from a borrower to cover loan processing fees.

Prepayment Penalty

A financial penalty that a borrower incurs if they pay the loan off ahead of schedule (loans will specify whether they include a prepayment penalty).

Principal

The total amount of money a loan is worth (excluding interest and fees).

Promissory Note

A written legal agreement stating a borrower will repay a specified loan value by a specified date.

Promissory Note Guide

Secured Loan

A loan backed by collateral.

Soft Inquiry

A type of credit check that does not report to the three main credit bureaus and doesn’t impact the borrower’s credit score

Term Length

The amount of time from when the loan starts until final payment is due.

Unsecured Loan

Loan without collateral attached (like a personal loan).

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How to Account for Interest on a Loan

Part of personal finance is knowing the cost of borrowing, otherwise known as an interest rate.

Loans may use one of two interest methods:

  • Simple interest: Percentage of the loan’s principal amount. Typically results in less total interest paid!
  • Compound interest: Percentage of the loan’s principal amount + interest that accumulates over time. You typically pay more over time when paying compound interest.

Personal loans and lines of credit are typically short-term loans, which usually use a simple interest method. Mortgages in the US also use a simple interest method, but varying principal payments may make it seem like interest compounds. 

A typical place you’ll see compound interest is with credit cards. Unpaid credit card debt compounds interest rapidly, which is part of the reason why the average American owed $6,270 in credit card debt in 2021.

Individuals receive tax breaks for interest paid on home loans, student loans, and investment property loans. That’s why it’s important to keep track of your interest paid on certain types of loans. Regardless of whether you receive a tax break, you’ll want to know how much to set aside for loan amount and interest payments. Look at your loan’s amortization schedule to determine how much money you’ll pay in interest over time. Then, track the interest payments as you make them. 

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FAQs About Borrowing Money

Answers to your most commonly asked questions about borrowing money.

Should you borrow money from strangers?

It’s best to avoid borrowing money from strangers. Scams are rampant in today’s world—the Federal Trade Commission (FTC) said people submitted 204,967 loan or lease fraud identity theft reports in 2020. 😅 You can avoid this by borrowing from official banks, P2P lending platforms, or friends and family that you personally know.

Advice on Borrowing From Strangers

When is it okay to borrow money from friends and family?

The best time to borrow money from friends and family is when you’re confident that you can repay them. The lender (aka the family or friend you are borrowing from) should also be comfortable. You may borrow money from someone you know to buy a house, start a business, or get over a financial hump, there are many use cases for social loans

By setting up and signing official loan documentation, you can make sure your relationship won’t go south. Pigeon provides you with an opportunity to create a repayment agreement that includes the loan principal, interest rate, and payment due dates.

Good Reasons to Borrow from Friends and Family

Can borrowing money help your credit score?

Your credit history is a collection of proof that showcases your ability to borrow and repay money over time. After the initial hard credit pull of taking out a loan (which typically lasts two years), borrowing money can help increase your credit score if you make your loan repayments consistently and on time. On the contrary, if you fail to make your required repayments, you can seriously hurt your credit score.

How a Personal Loan Could Affect Your Credit Score

Should you borrow money to invest?

Whether you’re investing in property or stocks, borrowing money to invest is called investing on margin. Investing on borrowed money is risky and can prove detrimental if your investment loses value. It can also be tricky if your brokerage asks you to do a margin call, in which you sell your position to liquidate it or add more capital to keep it.

If you’re a well-versed investor with a secure risk management strategy, investing on margin may prove fruitful. In this case, experts suggest limiting your margin to about 10% of the asset’s value.

Are traditional lenders better to use when borrowing money?

Not necessarily—here’s why.

Some traditional ways you can borrow money are through a hard money lender or portfolio lender. Private hard money loans are categorized by higher interest rates and secured collateral. Portfolio lenders provide loans originated and managed by banks or private institutions. It can be difficult to obtain a portfolio loan, but borrowers with good credit are more likely to receive approval than those with bad credit.

In the right circumstances, friends and family can make it easy to borrow money. You don’t need to fret over your credit score and can negotiate a fair interest rate that isn’t predatory. This makes repayment that much easier—which is good for the borrower and the lender.

Can you get a lower interest rate on already borrowed money?

It’s possible to refinance a loan for a lower interest rate. If you can reduce your interest rate by 2% or more, refinancing may be worth it. If you’re borrowing money from friends or family, you may be able to negotiate a lower interest rate and sign an updated version of your personal loan contract without much hassle. Keep track of every loan contract iteration with a platform like Pigeon.

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Bottom Line

With so many financial products out there, it’s best to prepare yourself before borrowing money. Do you know which loan method is best for you, how much you’ll owe in interest, and how to properly go about getting a loan? And more than anything, are you going into the situation as a confident borrower? Let this guide on borrowing money lead the way.

If you decide that borrowing money from friends and family makes sense for you, Pigeon is ready to help you get started. 🐣