Financial Pros Offer Guidance on Informal Lending

More than a few Americans face big challenges getting a conventional auto loan from an established lender. Even though new reports suggest lenders are widening the net just a little to accommodate the millions of consumers whose credit has taken a hit from the financial downturn, that still leaves out the growing ranks of the “bad credit” customers who just don’t look good on paper. Basically, any individual who has any past black marks on their credit is not going to look great on paper, unless lenders factor in items like income and assets. Since a great number of lenders tend to rely on simplistic credit score information, many of those seeking auto loans are left out in the cold.

When you’ve been turned down by a conventional lender, it may be tempting to just go to family members or close friends with money, but according to a recent Bankrate article, there are some hidden issues that can make these kinds of informal agreements dangerous. Bankrate cites counsel from Susan Hirshman, a financial writer with a lot to say about the art of the informal auto loan deal. Many of the ideas that Hirshman suggests for loans from family and friends can also be helpful when you get a more conventional loan from a dealership, especially from a smaller lot where the dealer may be willing to finance “off the books.”

First, get the whole deal in writing. This often helps both parties and keeps the terms of the auto loan clear. It also helps to talk up front about what happens when the borrower defaults, or falls behind.

Another tip is important for those who may not understand how the IRS sees informal lending between two individuals. The myopic tendencies of this federal agency mean that a deal that doesn’t include interest or is not formally structured can be seen by the IRS as a “gift,” triggering requests for applicable taxes from the lender. To avoid this kind of common misunderstanding, families should resist the urge to do a “simpler” loan and make the agreement conform to what typical lending looks like, and no, the IRS probably won’t see a six-pack purchased for the lender at maturity as “interest.”

Experts also suggest using peer-to-peer lending sites if possible. These venues strike the right balance between formal lending, which can be entirely too restrictive, and asking family members for money, which can turn out badly or be pretty awkward. If you are one of many needing to get around the roadblocks of big-market lending, think about this the next time you look for creative financing options for your next auto purchase.