Considerations When Lending Money to Friends or FamilyOct 22, 2021
It’s wonderful to be able to help a friend or family member with a financial challenge, but money has a way of creating disagreements and hurt feelings. Many financial experts recommend never lending money to loved ones. But every situation is different. It’s important to consider all the issues and then make your best decision.
If you’ve decided to make a loan, taking these steps will help ensure things go smoothly:
- Consider making the loan a gift. Without any expectation of being paid back, there’s less opportunity for the relationship to be harmed.
- Be sure you can afford it. It doesn’t make sense to create financial challenges for yourself.
- Avoid lending additional money. It can be wise to get all of your money back before you make a second loan. Many people have financial issues as a result of poor financial habits. It’s unlikely that a loan is going to help in some cases. Be firm.
- If they were unable to pay back the first loan, the odds for an additional loan won’t be any better.
- Consider creating a loan agreement (Get it in writing). A document will make the loan feel more formal, and your friend or family member is more likely to take it seriously. In the event that you need to take action to get your money back, having some paperwork is bound to help.
- Be clear about your expectations. If you make it clear that you’re happy to help, but it’s also important that you’re repaid, your borrower will have a better understanding of the need to be responsible. Be honest and open about the importance of being paid back.
- Consider a peer-to-peer lending tool. There are websites that will administrate personal loans. The program keeps track of payments and will send reminders.
- This does add some expense to the loan, but your borrower will be nudged if he doesn’t make a payment on time. And you don’t have to do the nudging!
- Keep these stats in mind. Surveys have shown that 45% of people that make personal loans aren’t paid back entirely. And 25% never get paid back at all! Understand that the likelihood of getting paid back isn’t great, less than 20% (and I think that number is generous).
- If you can’t afford to lose the money, consider refusing to make the loan.
- Charge some interest. This might seem a little unkind, but charging interest has multiple benefits. It lets the borrower know that you’re serious. It also avoids any potential gift tax by making it clear that it’s actually a loan. The IRS has interest guidelines for family loans. Be sure to check them out.
- Consider what you’ll do if you don’t get paid back. What will you do? How will you feel? The answers to those questions might change your mind about making the loan. Are you willing to just let it go? Are you going to take them to court?
- It might be best to just say “no.” In some instances, refusing to make the loan might be the wisest option for everyone involved.
- If you really need to be paid back in full and you believe the borrower won’t honor the agreement, it might be better to disappoint them instead of putting yourself into a financial bind.
Lending money to friends and family is a kind gesture but full of potential pitfalls. Personal loans aren’t reliable. If you decide to make a loan, communication is critical. Ensure that everyone understands the details for the best experience for all involved.
I have written articles about lending money before and I believe they are worth reading. It's not something I recommend, as the lender nearly always becomes the bad guy and the relationship rarely survives unscathed. Read my thoughts here and make an educated decision.
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