What You Have to Consider Before Lending Money to Family and Friends
Money is a leading cause of stress in relationships, not just with couples but with families and close friends as well. Loans between family members can be a touchy subject and can make for extremely awkward holiday gatherings.
A 2016 study conducted by MyBankTracker found that 17% of individuals said they’d had a bad experience with lending money to a friend or family member.
Out of people who lend money to family members, the most common loan is from parents to children, followed by sibling to sibling.
Other scenarios may be from children to parent, aunt/uncle to niece/nephew, or vice-versa. Non-family loans may be between friends, neighbors or coworkers.
If a relative or friend asks you for a loan, be prepared for your relationship to potentially change.
Even if you think things will be the same, you will now have a business relationship with them.
If they do not follow through the terms of the agreement, you may have to choose whether to forgive the debt, sue them, or take collateral. Even if you take no legal action against them, you may experience irritation, frustration, and resentment towards them.
It’s possible that holidays and get togethers you once enjoyed will now be dreaded events you wish to avoid.
Before you decide one way or the other, make a list of pros and cons to help you decide whether to loan the money, give a gift instead, provide assistance of some other type, or simply do nothing.
Although the benefits may be helping out a loved one, and potentially making money on interests, consider what are the risks, especially in the worst-case scenario that they don’t, won’t or can’t pay it back.
Will you suffer financial hardship, have to delay your retirement, or drain an emergency fund?
Things to Consider Before You Get Out Your Checkbook
What are you lending money for?
Ultimately, the decision whether to lend money to a family member or friend is yours, and there are no hard and fast rules.
But one thing to think about when making the decision is the purpose of the loan.
Some of the reasons you may consider lending money include:
- Buying a home
- Starting a business.
- An emergency car repair
- A medical or family emergency
- School tuition or certificate program
- Living expenses following loss of employment
Saying “no” to a request for a loan may be extremely difficult, but it may be the right thing to do.
You can say no with an honest explanation that shows it was a carefully considered decision.
If the decision to say no is based on the requester’s financial situation, be as tactful as possible, especially if the requester is a close family member you will continue to have regular contact with.
It’s possible that you can simply say that you cannot afford to give.
Although if you are obviously in a comfortable financial situation, that can be more awkward. Along with saying no, you may consider other ways to help.
Are you enabling the person, or helping?
If your loan is a temporary band-aid to an imploding financial situation, you might be doing more harm than good.
If someone mismanages their finances to the point they are behind on their mortgage and bills, and you are lending them $1,000 for an emergency car repair, you might be fixing a temporary problem, but your “coming to the rescue” may be encouraging bad spending habits to continue.
If you are unfamiliar with the person’s current financial situation, you should ask questions about their current debt, expenses and obligations so that you can understand their ability to pay.
Although it may be uncomfortable to ask for this information, you can explain that any lender would need to do some screening to make a lending decision.
If the loan is significant, you may even ask for a credit card statement or a copy of a recent credit report.
If the requestor refuses to provide this, you should be especially careful about lending the money.
If you are lending money to consolidate someone’s maxed out, high-interest credit card debt, you may ask the borrower to cut up credit cards or give you their credit card to store in a safe place until the loan is paid off.
Although there is an element of trust in such a request (they could easily call their credit card company and replace the card), a written and signed agreement can offer assurance of their ethical and moral obligation to repay you, along with the legal agreement.
Whatever the terms of the loan repayment are, you should get them in writing.
Is your family member or friend serious about paying you back?
When you lend money, you are the bank.
If the person you are lending money to thinks that you do not need the money, or that the terms of your loan are open-ended, they may not prioritize paying you back.
It can be extremely uncomfortable if someone owes you money, and you are forced to nag them constantly to pay you. You will now become a debt collector.
In cases where the person receiving the loan feels that the person giving the loan should want to gift them the money, they may not want to pay the loan. If the person has any resentment or bitterness towards you or your financial situation, do not lend the money.
This is more common in situations where the lender has come under a financial windfall, such as an inheritance or financial settlement.
For example, you receive a $100,000 settlement and your sister is struggling to raise three kids by herself.
You help her out with a $10,000 loan to buy a used car, and she may not think you need the money.
As the lender, you need to make it clear from the very beginning, that the terms of the loan are no different than a loan from the bank.
The fact that the borrower knows you well (and you care about them) does not lessen any responsibility or obligation to pay back the loan.
Is there no other option for them?
If the person asking you for money has no income or is unemployed, they may not be able to qualify for a personal loan.
Ideally, they should be able to qualify for a loan.
You may even ask them to apply for a personal loan for the amount, and pay the same terms to you, or a slightly lower interest rate.
The fact that they qualify for a loan based on their income and credit score is a positive indicator that they take financial obligations seriously and are able to repay financial obligations.
If they do not qualify for the loan, and you ae the only option to provide funding, you could consider asking for collateral for repayment, such as a vehicle, piece of jewelry, or other valuable. This can be a simple written agreement.
Can they really afford to pay you back?
If you are considering a loan to a relative or loan, it’s unlikely that you’re asking them for a copy of their credit report, or an accounting of their monthly income and monthly expenses.
But if the person is unemployed and has no income, or living paycheck to paycheck barely making ends meet, consider their ability to pay you back based on the terms you come up with.
If you want to help, but feel they will struggle to pay you back, consider giving them a gift instead.
Even if it is not for the amount they are asking for, a gift of a smaller amount may be more generous than a loan they cannot afford to pay back.
Does this person have good communication and good money habits?
If the person asking you for a loan has lied to you before, or lied to others, you should be prepared for them lying to you about circumstances of the loan.
If it is difficult to discuss the terms of the loan before you write the check and give them the funds, it will be even harder after.
Is there another way you can help instead of lending money?
If you want to help someone, but are hesitant to actually give them money, consider finding other ways to help.
Perhaps they have children and you can offer child care. Or you can provide groceries or pay a utility bill.
Can you live without the money, if they don’t pay you back?
One way to think about it – are you going into debt to finance someone else’s debt? If you lend money to family, you should be prepared to live without it.
If you will have to postpone your retirement, not travel, or otherwise suffer financial hardship if they do not pay back the loan, think seriously about if it’s something that you want to do.
Would they do the same for you?
One final thing to consider is the human aspect of it. If the situation were reversed, and you had the financial need, would they consider giving you the same generosity you are considering extending to them?
Whatever you decide, remember the reason for your decision and strive to never let money come between friendships or family.
If you say no, strive to be empathetic and compassionate in communicating your decision, and look for other ways to help your loved one in improve their situation.