Lending money to loved ones is often a bad idea because it puts your relationship in jeopardy. But when someone you love is in a serious bind and you have the means to help, it can be impossible to say no. So what do you do?
What you don’t do is lend money on good faith and expect to be paid back. Just as if you were loaning to a complete stranger, you need to be smart about setting up the terms and a schedule for repayment with your friends and family. But as long as you and your money stay protected, lending to someone you love is doable – even if it isn’t necessarily advisable.
How to Lend Money to Loved Ones
When someone you love asks you to hand over your hard-earned cash, give yourself time to consider your answer. Ask what other avenues he or she has sought to procure money. Chances are your loved one is deep in debt and won’t qualify for a traditional bank loan or peer-to-peer lending. But still, it pays to ask – and make it clear that if you’re to consider lending money, you require full financial disclosure.
Consider these additional tips to lessen the stress of lending to friends or family:
1. Deal With Cash Only
If a sibling asks you to open a credit card in your name for his or her use, or requests that you co-sign for a loan, shut down the scheme as soon as possible. Never put yourself in a position where someone else’s actions could affect your ability to borrow or secure credit in the future. You can control cash, and lending it won’t directly affect your credit score. If a loved one asks for help, only deal with cash or politely decline.
2. Only Lend What You Can Afford
There’s an old gambling saying that you should never bet more than you can afford to lose. The same can be said for lending to a friend or family member. Since the money might never be paid back, you need to decide if you’re willing to forgive the debt in order to save the relationship – so if $5,000 could break you financially, don’t lend it.
Even the most well-meaning loved one might fall on hard times and default. Ask yourself whether you are okay with that. If not, don’t dole out the loan.
3. Consider the Impact
When you lend money to a family member, you impact just about everyone else you’re related to. Allowing one family member to borrow and not another could drive a wedge into your relationships. Other family members might see favoritism or enabling, so seriously think about how going through with the loan will make others feel.
If you’re a parent considering loaning money to a child, it might even be a good idea to call a family meeting to discuss the terms openly. That way, none of your other children will be confused or hurt by the decision.
4. Get Full Details
While you might be anxious about hurting a loved one’s feelings, you need to know where your cash is going to decide if it’s worthy of a loan. A bank would never blindly hand over funds without knowing what it’s being spent on, and neither should you.
If a family member becomes offended, take it as a red flag that it’s not a deal you should make. And if you are provided details, follow up on them. For example, if a friend asks for a couple thousand dollars for a down payment on a home, check out the house, its cost, neighborhood comparisons, and how a down payment will affect the mortgage. Investigate all of these variables prior to making your decision.
5. Charge Interest
Charging interest to a family member or friend might seem unnecessary, but it’s the fairest way to protect yourself. Not only will a fair interest rate inspire your family member to pay you back in a timely manner, but it can also protect you from being charged gift taxes on the money you lend. As of 2012, if you lend more than $13,000, you’re liable to pay a gift tax on that amount if you don’t set a loan with reasonable terms and get it in writing. For larger loans, confirm with an accountant what you need to do to protect yourself.
6. Discuss Terms
Talking about money with family members can be awkward, especially if you’re in a position to lend. But glossing over the details can possibly hurt you both. Make sure that you clarify the amount being loaned, the interest rate, the repayment schedule, and late fees well in advance of any money changing hands. Immediately getting the terms out in the open reduces the possibility of any future miscommunication or confusion.
7. Get It in Writing
While a verbal agreement is considered legally binding, it still comes down to your word against someone else’s – and even if you trust your loved one to abide by the parameters you set, you could land in hot water without a written agreement.
Having written details that both parties agree to by signature is also a great tool to prevent misunderstandings. Should legal action ever become necessary, a written contract is nearly ironclad in court, which protects you far more than a mere handshake.
8. Practice Worst-Case Scenarios
While discussing the loan terms might seem awkward enough, you still must consider worst-case scenarios. Sit down and talk about what would happen if your loved one makes late payments or doesn’t pay you back at all. You need to talk about a plan of action, be it late charges, a collection process, or legal action. This sets the standard for the business relationship, so you both know what will happen if the deal goes sour. While it might not stop hurt feelings, it should eliminate any surprises if your borrower eventually defaults.
9. Distance Yourself
One of the biggest mistakes you can make when lending to friends and family is to micromanage that person’s spending after you’ve made the loan. Once you’ve agreed and inked the deal, the money that you lend is no longer in your control – obsessing over how it’s spent will only foster problems. Separate yourself from the money and focus on repayment, not on how it’s spent.
When to Say No
If you aren’t comfortable with the lender-borrower relationship, it may be in both your best interests to decline your loved one’s loan request. Money can be a serious force in driving apart friendships and family relationships, so trust your instincts and simply decline if you feel uneasy about the deal. Perhaps you can help in other ways: offer a small cash gift, buy groceries, or find other service-based ways to lend assistance.
Is lending to family members or friends the best financial decision you could ever make? Probably not. But all financial advice aside, sometimes your relationships trump traditional money sense. If you absolutely must lend to someone you love, just make sure you do it with your head, and not your heart. Being too forgiving or trusting might be admirable, but it can also lead to you being taken advantage of, even by someone who has the best intentions.
Do the work, prepare for the worst, and work to keep your relationship as stable as possible to make lending money a positive experience for both parties involved.
Have you ever loaned money to a family member or friend? If so, did the experience put any strain on your relationship?
(photo credit: Bigstock)