What Are the Dangers of Borrowing Money?

Getting a loan from loved ones can create tension in a relationship. Owing someone money can make you feel vulnerable or inferior because you lack the financial means to satisfy a debt or cover a future cost. Obtaining a loan from the bank, while eliminating the emotional risks, often entails more severe financial and legal consequences if the loan is not paid back per the agreement. Before borrowing money, you should consider a number of factors.

Features

Borrowing money from individuals involves the exchange of money accompanied by an understanding that the money will be repaid. Sometimes money is lent on the condition that it will be repaid by a certain date. In some instances, interest may be charged. This is typically required when obtaining a loan from a bank or another financial institution.

Function

There are different reasons why someone might need to borrow money. Sometimes individuals find themselves in a financial rut. Other times individuals may ask to borrow money to engage in an endeavor, such as opening a business, which they are unable to afford at the time. In these instances, the borrower may be required to pay back the money in installments, as opposed to one lump sum. Installments are typically paid on a regular basis, such as monthly or weekly.

Types

The two main types of loans are personal and commercial. Personal loans are usually less structured regarding reimbursement since they often occur between close friends or family. However, an individual may have to reveal personal information to explain why the loan is needed. Commercial loans require a much more detailed explanation as to why the money is needed as well as when and how it will be paid back. Banks and other financial institutions require collateral and a contract to ensure they will get their money back.

Considerations

The amount of money borrowed should not exceed what an individual is capable of repaying. The terms of the agreement should be acceptable to both parties. For personal loans, you may want to consider a written agreement which includes when the money will be paid, what interest there will be, if any and what the penalty will be if the terms of the agreement are not met. For example, signing a promissory note, which is an unconditional promise to pay a certain amount of money, can protect you from exorbitant interest or penalty charges. Promissory notes are contracts and legally binding.

Effects

Inability to pay the money back can have devastating results. For personal loans, the borrower may constantly be reminded that money is owed or feel pressured to do something for the person making the loan in return. When payments are not made in a timely manner, the matter can be turned over to a collection agency if there is a signed contract stipulating how and when the money would be paid. This can destroy your credit rating and prevent you from obtaining future loans.

Resources

• Federal Trade Commission- Consumer Credit Information
• Lending Tree