Friends & family: rates low, but hidden costs come later.

Overview: Loans from family and friends are among the most appealing options for those in dire need. They offer instant cash, little or no interest, no collateral and no demand letter.

But you still have to see your creditor over the holidays.

"Sometimes, if a relative loans even a small amount of money, like $500, that doesn't get paid back, they'll write off a family member," said Jennifer Root, a spokeswoman for the Consumer Credit Counseling Service of Los Angeles.

Yet, in many instances, the lender has no expectation of getting paid back.

Most family-and-friend loans fall below $1,000 and are used for immediate needs like medical bills or a mortgage or rent payment. When the lender is wealthy, the amounts can go higher.

Borrowers also use family loans to start businesses or, in the case of a family business, provide a cash infusion for product launches or new store openings.

Many times, terms and conditions of the loan depend less on market rates and more on how much the lender likes the borrower, their expectation of repayment and what percentage of their net worth they are lending. Beyond financial risk, there is always the possibility of losing a friendship or alienating a family member. Borrowers can get upset if a lender expects repayment.

Lenders: The most likely lenders are morn and dad, said Jeffrey Forer, of counsel with law firm Weinstock Manion Reisman Shore & Neumann Corp. Half his clients have loaned money to their children, often more than once. Parents lend to kids who are just starting out or, if the kids are well to do, to children who choose to be an artist in Paris rather than a doctor or lawyer.

Whether the children consider them loans is often an issue.

When one child gets a loan, and another child does not, feuds between siblings are common. Often, parents who give a first loan to a child may take the opportunity to do estate planning and forgive the loan payments in their will or inheritance.

Tim Lappen, chairman of the family office practice group at Jeffer Mangels Butler & Marmaro LLP, said parents who give to their newlywed child might later consider it a loan if the marriage falls apart.

Other big lenders are the super-wealthy, who get solicited by everyone from their children to their gardener.

Borrowers: Typically they're children or siblings in a family business. Other borrowers could be the fellow country club member who needs an advance on a new house, or the friend whose business is short on cash and has a big contract coming up.

As the economy limits the financial resources of struggling small businesses, family members have loaned and borrowed more frequently.

Rates: Often, family-and-friend loans are interest-free. Under tax law, they must come with interest, so some relatives and friends lend to get a better investment than they would from a more traditional loan.

Even if the loan is interest-free, the federal government computes an imputed interest, which is very minimal, for the borrower to deduct and the lender to declare as income.

Family members and friends of more modest wealth may charge interest rates if the loan is substantial. Root said her own grandmother charged 6 percent interest on a loan she used toward the down payment of her house. She said one client pulled out a loan, with interest, from his dad to pay for his entire mortgage. When it is charged, interest on a business loan typically runs at a higher rate than a conventional bank loan.

Collateral: Even if they ask for interest, many lenders of family-and-friend loans rarely ask for collateral. When the lender is wealthy, however, the amounts are often larger - and loans more frequent. Wealthy lenders are more likely to demand collateral because they have lawyers who draft all loans in a business-like manner.

In those cases, collateral can be anything from a borrower's car, house, stock or inheritance. Usually, the point of asking for collateral is to reinforce the idea that the loan must be paid back.

Voices

Jonas Chesta

Counselor

Consumer Credit Counseling Service of L.A.

"The last one I had was a younger guy, in his 20s, who had bred cocker spaniels. He had borrowed from his sister, but he used his family dog, so he didn't borrow that much. Now, he wanted to borrow money from the family to breed Shih Tzu. It was going to be between $800 to $1,000 from his parents and his sister. He considered it an investment, not borrowing. That was his plan. He was hoping he would have puppies by Christmas.

"I told him, 'the way the economy is now, you won't get the full price of the dog you did previously. People may not be able to spend a couple hundred dollars on a Shih Tzu.' I don't know what happened, but I'm going to say he didn't get the money."

Jeffrey Forer

Of Counsel

Weinstock Man/on Re/smart Shore &

Neumann Corp., Los Angeles

"A couple of brothers were fronting a sister a bunch of money to get a house and start her life. She had shares of stock in the company. It was a note for $500,000. She was supposed to pay it back in five years. She paid for the first six months, about $50,000.

"They gave her four years, and she didn't pay. It was a printing business. The business wasn't doing as well as it should have, and they weren't taking out large draws, so they foreclosed on her. She got to keep the house. But, in essence, she sold her stock to them for the loan. There were some hard feelings, and they don't talk anymore."

David Russell 

Director

Family Business Center at California 

State University, Northridge

"I lent money to a friend who was involved in a business. I had lent money to him before. He was a long-time friend. It was a publishing business, a startup publishing business. I wanted to participate in my friend's success and get the interest of that transaction.

"The business took longer to mature than expected. And, despite the best intentions, the business did not grow as rapidly, and the borrower found other uses for what might have been repayment money. I was expecting the money in a year, and several years later, the money still is outstanding.

"There have been interest payments along the way. But, despite years of delay, I still believe the friend will perform."