Should you loan money to friend or family member? It’s a complicated, and often emotional subject.
While it’s natural to want to help the people in your life, in a worst case scenario loaning money has the potential to destroy relationships. There are no easy answers.
Here are some tips if you are considering loaning money to family or friends:
1) Only loan what you can afford to lose. The reality is that you might never see your money again. You can minimize the pain of default by only loaning what you can afford to lose.
- Even the most responsible of your friends and family can default under unfortunate circumstances. Job loss, economic downturns, and medical expenses are common causes for otherwise responsible individuals to default on their financial obligations.
2) Offer help instead of money. In some cases, providing money only addresses the symptom of a greater problem. Focus on what lead to the financial hardship in the first place. Offer to help make a budget, find employment, or speak wisdom into their situation.
3) Put everything in writing. Spell out the terms of the loan, including the amount and the repayment details. Putting both your names on the dotted line will help to motivate your borrower to make timely payments.
- For large amounts, consider using a lawyer to draft the final agreement.
4) Consider how the rest of your family and friends might react. Have you turned down others for loans in the past? What will those people think if you’re willing to loan money to someone else? Will your loan be viewed as enabling bad behavior, such as poor spending habits or refusal to get a job?
5) Stick to cash. Avoid cosigning a loan or a credit card. If the borrower has poor payment behavior it could have a negative impact on your credit and ability to borrow in the future.
6) What will you do if they default? Will you ask for collateral? Are you willing to take the borrower to court? Will you end the relationship? Have a plan for how you’ll handle non-payment.
7) Charge interest. The situation feels more formal and serious if interest is charged. You’ll also feel better about your money working for you. You should talk to your tax professional to determine the appropriate rate for the loan.
8) Talk to your spouse. If you are married, ask for the blessing of your spouse. People have differing opinions about loaning money to family members and friends.
- The last thing you want to do is create friction at home. You could be straining your finances and your relationship.
9) Be able to say “no.” Your intuition is usually a good indicator on when it makes sense to loan money to others. There are times when saying “no” is the only reasonable course of action. Avoid being afraid to refuse requests for money. Follow your gut.
The decision to lend money to a friend or family member is a personal one. Consider the various ramifications of loaning money to someone you know well. For the best outcomes, always tread carefully, communicate with all parties clearly, and make the wisest decision you can.