If lending money to a friend can be awkward and risky, then why do it? Because when it's done right, it can be incredible!! Frank explains.
As Part 1 explained, it can feel weird and risky to help a family member. The prospect of getting someone to pay you back can seem like more pain than it's really worth.
So why lend money to friends and family?
Because if you do it right, it can bring two important benefits to you and the people around you:
- (1) Economic: You can keep a lot of money within the family
- (2) Emotional: It can make everyone feel great
Let us explain.
There's a huge economic surplus when you cut out middle men
Let's just take a walk down 'the economics of the spread' lane:
- The average interest rate paid to a bank credit card is about 13%. The average interest rate paid to a savings account holder at a bank is a whopping 0.06%. That's a 13% spread.
- The average interest rate paid by a borrower on a P2P platform is about 15%. The average return paid to P2P lenders is 6–7%. That's an 8% spread.
- On a government-subsidized home loan the average interest rate is about 4%. But a lender is lucky to be earning 1–2% on their government bond. That's a 2–3% spread.
- And don't even get me started on short-term payday lenders.
Some of that spread is because of perceived risk for the institutions and that is fair.
But a lot of it — and in the case of P2P lending, all of it — is a result of additional transaction costs (e.g., credit scoring, marketing, compliance) and profit for the middle men.
But what if you could eliminate those transaction costs and cut out the middle men?
As we've shown over and over with Frank, you can! And when you cut out the middle men, that 3–13% gets shared between you and your friends/family. How great is that?
Whether it's a high or low interest rate environment that spread will always exist. That's why — when you do it right — lending money directly to a friend or family member will always create incredible economics!.
There's a big emotional benefit
A lot of people like to focus on the economic advantage of a social lending platform, and we think that's great.
But what we hear from our users at Frank is that the biggest benefit they get is the positive feeling from being able to help out the people they care about, without the worries or stress.
As researchers from Harvard have shown, giving increases happiness. Helping out a cousin or colleague in a bind not only helps them and can earn you a little money, it can also make you feel happier too. So if you can unlock that relationship, you can capture that happiness.
And if there is a way for that cousin or colleague to feel like they helped you too, that can make them feel happier too.
That's why the most effective interaction is to let the borrower decide how much interest they want to pay.
This model allows you to feel good by helping them and it allows them to feel good by helping you right back.
Because when you structure it the right way, lending money to a friend can feel great, not weird.
And we all know a little bit of happiness is priceless. :)
Win, Win, Win, Win
A win on the economic side and a win on the human side!
Different people will strike a different balance on how much of the incentive is emotional and how much is economic. That's totally expected.
So now how do you structure it in the right way? That's why we built Frank.
Check out Part 3: The Awkward Ask or Offer details how to approach a friend as either a potential lender or a potential borrower.
This is Part 2 on our series about the challenges and solutions to lending money to friends and family
Part 5: How do I Get Paid Back Without Being a %$^?
Part 6: Power Dynamics with Friends and Money
Part 7: Friendships at risk
Part 8: Something Went Wrong, Now What?
D'Arcy Coolican, Co-Founder, Frank
Frank is a platform that uses behavioral research to help make it easy to lend and borrow money with friends and family.