Avoiding the Pitfalls of Family Borrowing

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Sometimes borrowing a little money from a family member can turn into a big bundle of stress. A Boston-based company, CircleLending, specializes in making sure that family loans are done without misunderstandings.

STEVE INSKEEP, host:

Many first-time home buyers borrow money from a family member or a friend to make a down payment. But private loans are often risky, and the default rate is much higher than doing business with the bank.

Now a young entrepreneur has created a special loan company exclusively for financial transactions between friends and family.

From Boston, Rachel Gotbaum reports.

Mr. JONATHAN DOYLE(ph) (Home Buyer): Here's the kitchen, and my mother did a wonderful job keeping it up. We've got all knotty pine cabinets and all that.

RACHEL GOTBAUM: Jonathan Doyle is showing off his new, three-bedroom house. Actually, Doyle, who's 36, grew up in this house south of Boston.

But last year, his mother sold him the family home and lent him the money to buy it.

Mr. DOYLE: I could have never even come close to buying a quarter of a house like this if it wasn't for my mother.

GOTBAUM: Here's how it works. Joan Doyle, Jonathan's mother, is now essentially her son's mortgage broker. She lent him the $225,000 to buy the house, a discounted price, and now he pays her a monthly mortgage with interested that is automatically debited from his bank account.

Ms. JOAN DOYLE (Mother): He was a little bit nervous about taking on a house. But I knew we could do it. And I knew that he would have quite a tax write-off at the end of the year, which he has never had before.

GOTBAUM: To make all this happen, the Doyles went to Circle Lending. The company, based in Waltham, Massachusetts, sets up loans between family and friends. It was created by 35-year-old Asheesh Advani.

Advani was working at the World Bank when he came up with the idea.

Mr. ASHEESH ADVANI (Circle Lending): If you actually study what happens in these private loans, they don't often go that well. That told me that the relationship between individuals is jeopardized by these private loans unless there's a clear understanding of what's a loan, what's a gift, and when the money is to be repaid.

GOTBAUM: Since it was established just over five years ago, Circle Lending has facilitated over $100 million worth of loans. Clients pay from $200 to $2,000 for Circle Lending's services. About two-thirds are business and personal loans. The rest are mortgages.

Mr. ADVANI: The primary motivation for using Circle Lending for mortgages is to keep wealth within the family. You can get an interest rate from your parents of four percent or five percent, while if you go to a bank it's six percent or seven percent. And you get to keep that five percent interest within the family unit. You aren't throwing away six or seven percent to a bank.

GOTBAUM: Advani says by putting a formal structure around financial transactions between friends and family members, his company has been able to cut the default rate on these private loans from 14 percent to under five percent. For mortgages, the default rate is about one percent - in line with commercial lenders.

But critics say even with legal documentation in place, lending money to a friend or a family member is still risky.

Ms. TERRY SAVAGE (Personal Finance Columnist, Chicago Sun-Times): If a bank or credit card won't lend them money, why should you?

GOTBAUM: Terry Savage is the personal finance columnist for the Chicago Sun-Times.

Ms. SAVAGE: Before you as a parent give away money from your retirement account, you better think twice. You're going to create jealousies between children in the family. It's going to be very difficult to collect on this loan if one child defaults. And you're going to see a child perhaps go on vacation or buy a new car before that loan is repaid, maybe when you need the money for your retirement.

GOTBAUM: But Asheesh Advani, who created Circle Lending, says his customers have the same protections as the bank. Lenders can pursue a collection agency or take their son or daughter to small claims court, if needed.

Mr. ADVANI: Everything Bank of America can do for their clients we can do for our private lenders. So we can help you, if you want, restructure a private loan. If they want to foreclose, they can foreclose. If they want to claim it as a bad debt, they can claim it as a bad debt, all because you've put the paperwork in place.

GOTBAUM: Circle Lending began as a tiny startup with $30,000 borrowed from - you guessed it - family and friends. Recently, the company attracted $10 million in venture capital funding, and expects to double its clientele over the next year.

For NPR News, I'm Rachel Gotbaum, in Boston.

INSKEEP: And that's the business news on this Friday morning.

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