Borrowing between friends just got easier
Shakespeare had it all wrong when he wrote that to preserve friendship as well as money, “Neither a borrower nor a lender be.”
Both borrowers and lenders can profit -- and stay friends -- as long as they’re professional about it and put the details in writing. Or so says Asheesh Advani, chief executive of Virgin Money, a Waltham, Mass.-based company recently acquired by British airline magnate Richard Branson. Virgin Money, previously known as CircleLending, charges a fee to facilitate all kinds of loans -- including business loans and mortgages -- between people who are friends or relatives.
Why pay a go-between to get a loan from Mom? Jay Jilot of Reno did it because he wanted to document for the Internal Revenue Service that the $475,000 from his parents was really a mortgage loan -- not a gift -- and that therefore the interest was tax deductible.
“In our mind, having a third party involved would mean there would be no question for the federal government -- or anyone -- that this was a home loan,” said Jilot, 37, who borrowed the money to buy his dream home with his wife, Cassie. “They do the reporting for me so I can deduct the interest.”
About $89 billion in loans between people who are friends or relatives are made each year, Advani said. They can be trouble because the terms are often vague, the options if the borrower encounters financial problems aren’t spelled out and, after the loan is made, the parties may feel awkward about the arrangement. Or, as Shakespeare wrote, “loan oft loses both itself and a friend.”
“The typical behavior is to say, ‘OK, here’s the $25,000. I’d like you to pay me back in three years,’ ” Advani said. “There are no details. No payment plan. That creates a lot of uncertainty.”
But if done well, loans between friends can benefit both sides, he said. The borrower can get a good interest rate and the lender can earn a competitive return on his money.
How does it work when friends have an intermediary handle the details? Here are some questions and answers.
What’s the benefit of using a go-between for a loan between friends?
A third party will do the math and the paperwork, which many people would find difficult.
For example, an ordinary calculator can tell you that simple interest on a $25,000 loan at 5% would be $1,250 annually. But determining the monthly payment necessary to bring the balance of a $25,000 loan down to zero after three years is more complicated. (It’s $783.41.)
An intermediary will also take care of drafting and filing any required paperwork.
For example, with any loan there should be a signed promissory note, a legally binding promise to repay the money. Mortgage loans also might need a trust deed and a lien on the property to be filed with the county. If the interest on the loan is deductible, whoever collects the payments needs to report to the IRS the amount of interest paid by the borrower (it might be deductible) and received by the lender (because it is probably taxable).
In addition, a third party can keep you from running afoul of some obscure tax rules, Advani said. Specifically, if the interest rate on a loan is below a certain threshold set annually by the IRS based on market interest rates, the agency considers the money saved by the borrower to be a “gift.” If the gift exceeds a certain amount, it may be subject to gift tax.
For Jilot, Virgin Money filled out the trust deed and promissory note and recorded the lien on his property. The company also sends him bills, processes his payments and sends tax forms to him and his parents.
What’s the disadvantage?
A third party costs money. In theory, if you are good at math and don’t mind picking up a few forms at a stationery store and spending a little time on the IRS website, you could do everything Virgin Money does. That would save the cost of the company’s fees, which range from $99 for a simple personal loan to nearly $2,500 for a mortgage. (There’s also a $9-per-payment fee if the company handles the payments.)
Who figures out the loan terms?
The borrower and the lender.
Jilot said Virgin Money arranged a conference call with him and his father. The Virgin representative walked them through various interest-rate and repayment options to help them determine what was workable. The parties eventually decided on a 40-year mortgage at 4.64% to keep the payments affordable.
What happens if you can’t make a payment?
You call and figure out a way to fix it. There are many options, Advani said. For example, you may be able to make up the missed payment over the remaining term of the loan, paying a little extra each month, or simply have the payment added to the end of the mortgage. You also can see whether the lender will “forgive” the missed payment.
Is there a fee to handle a “workout” when the loan doesn’t go exactly as scheduled?
No. The company used to charge a fee, Advani said, but realized it got more benefit from positive word-of-mouth by fixing the problem for free when clients needed help.
Does Virgin Money deal with all types of loans?
No. The company handles personal loans, mortgages, reverse mortgages and business loans in the U.S. It plans to start handling student loans next year.
What’s in it for the lender?
That depends on the loan. In Jilot’s case, his parents cared less about the money than about enabling him and his wife to buy a nicer home than they otherwise could have afforded. But his parents also earn interest that is at least competitive with that available on a bank certificate of deposit.
They could have charged more, say, 6%. That would have been less than the market rate on mortgages but more than they could have earned elsewhere.
“Most of the time the rate charged on our loans is 2% to 3% lower than market rates, but it’s higher than the rate the lender could have earned on an annuity,” Advani said. “Retired people in general might be delighted to be earning 5% on their money, particularly when they don’t trust the stock market.”
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Kathy M. Kristof welcomes your comments but regrets that she cannot respond to every question. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For past Personal Finance columns, visit latimes.com/kristof.
