Should You Loan Money to Family or Friends?

In these tough times, you need not worry about forming a theory of intimate usury. Sooner or later, someone you love will likely come to you for cash. No doubt, the mere proposition can be emotional. Do you say yes? Do you say no? What’s the fallout?

This is never easy. It may be easiest if things are excruciatingly hard for you: perhaps you really don’t have anything to loan. If that’s the case, be direct. “Say that you would like to help but unfortunately you are unable to. If they persist, point out your obligations, the mortgage, your child’s college tuition, or whatever the case may be,” says Bradford Pine, an investment advisor with Cantella & Co.

In other words, make it plain. You’re not being selfish. You’re simply declining to lend money you don’t have. This is kinder to everyone than something more extravagant, like a cash advance on a credit card. But, if you have the luxury of saying yes to the loan, decisions get a little more ticklish.

Some experts advise against lending to friends at all, and others say it’s proper so long as you proceed with caution.

“I have two words for someone considering a loan to a friend or family – be careful,” advises Pine.

Here’s what you need to think about.

Consider the worse case scenario. Even if you think there is little chance the debt will go unpaid, think in advance how you would react and actions you might take if the debt is not paid, suggests Karen Goodfriend, a member of the American Institute of Certified Public Accountant’s CPA Financial Literacy Commission. How might the borrower react if you took those actions? Would you still be glad you made the loan? Is it worth jeopardizing the relationship?

“Loaning money is high risk to relationships among friends and family. Although the person desperately needs your help, they may also secretly resent you for having something they don’t. After getting burned several times, I give to those in need, if possible, but hold no expectations for return. This way, it’s a gift and the tricky business of waiting for a return is eliminated,” says psychotherapist Dorothea Hover-Kramer.

Find out why the money is needed. If you still feel generous, be sure the loan is for a good and specific purpose. Is it for a car loan to help someone get a new or better job, or to help start a business? “If they’re vague about the use of the money, do not go forward,” says Pine.

Put it in writing. Leave no room for misunderstanding. The money is not a gift, it is a loan. To avoid confusion, document in writing the terms of the loan, like when it is to be repaid and how, even if you decide not to charge interest. Handshakes are never enough. Relationships can be ruined due to confusion about loan terms. Preferably use a promissory note. “This not only protects you, but sets the tone that you intend this to be a business-oriented transaction. You can further protect yourself by establishing collateral so there are some assets you can claim,” says Goodfriend. Get the agreement signed in front of a witness. Know too, that there may also be tax benefits to using a formal promissory note. If the borrower cannot pay back the full loan amount, the lender may be entitled to a tax deduction as “bad debt”, says Pine.

Be fair. Establish an interest rate and terms that are fair to you and also gives some incentive for the borrower to repay. If the interest rate is too low, the borrower has an incentive to not repay right away.

Loaning money to family and friends can make a big difference in someone’s life. But step deliberately so that you make the difference you intend to make.

Comments