What is a Friendly Loan?

A friendly loan is a financial agreement between associates. This type of financing is known as a friendly loan because the agreement is usually made between friends, family, or acquaintances. These types of loan agreements are rarely legally documented and stipulations are usually verbally agreed upon.

How a Friendly Loan Works

Friendly loans are the most common type of loan agreement, whether it be among friends, family, or work associates. In many circumstances failure to repay such loans cannot be legally challenged, as most friendly loans are made in good faith between closely associated parties. These loans are also not reported to any credit bureaus and do not reflect on one's credit score.

It is possible that a friendly loan might be requested by a personal contact as a way to beat interest rates that are charged by financial institutions. This can be seen as a benefit for both parties as the borrower is able to access funding at a discount and the lender gains an investment opportunity. However, any interest collected by a lender in a friendly loan will likely need to be reported to the Internal Revenue Service (IRS) as imputed interest for tax purposes.

Friendly loans are not reported to the credit bureaus and do not affect the borrower's credit score, but any interest collected by a lender will likely need to be reported to the IRS as imputed interest.

When a friendly loan is offered and agreed upon, it could include a formal promissory note or loan agreement documentation of the transaction. A promissory note would serve as a legal record of the amount borrowed and the terms, stating that the borrower will pay back that amount.

With a formal loan agreement the terms may be more detailed, defining the loan as secured or unsecured. A friendly loan that is secured means there is some form of collateral the borrower agreed would be surrendered if he or she defaults on the loan. An unsecured friendly loan would lack such collateral, but if the borrower defaults and there is a formal loan agreement signed by both parties, it could be the basis for legal proceedings to recoup the debt from the borrower.

Special Considerations for a Friendly Loan

Friendly loans can take the form of cash granted to a borrower. This may occur when someone who is more likely to be approved by a bank or financial institution takes out a loan and then gives those funds to a relative or friend who would not have been approved. One circumstance in which this might be done is when a friend launches a business venture. In such a case, the person who secures the funding and then lends it out is responsible for paying back the bank or institution—even if the friend or relative does not pay back the loan.