Lending money to loved ones is often a bad idea because it puts your relationship at risk. But when someone you love has a serious problem and you have the resources to help, it can be impossible to say no. So what are you doing? What you are not doing is borrowing money in good faith and expecting to be repaid. Just like when you lend to a complete stranger, you need to be smart and set up terms and conditions and a schedule for repayment. As long as you and your money remain protected, lending to someone you love is doable – even if it's not necessarily advisable.
How to lend money to loved ones
When someone asks you to borrow your hard-earned money, give yourself time to consider your answer. Ask what other avenues he or she has tried to get money. Chances are that this person is in debt and does not qualify for a traditional bank loan. Still, it pays to ask – and make it clear that if you're considering borrowing money, you'll need complete financial information.
Consider these additional tips to reduce the stress of lending to friends or family:
Cash only
If a sibling asks you to open a credit card in your name for his or her use, or asks that you co-sign for a loan, don't respond. Never put yourself in a position where someone else's actions could affect your ability to borrow or secure in the future. Borrowing cash does not directly affect your credit score. If a loved one asks for help, give cash only or be polite.
Only lend what you can afford
There is an old gambling game that says you should never bet more than you can afford to lose. The same can be said for loans to a friend or relative. Since the money may never be repaid, you'll have to decide if you're willing to forgive the debt to save the relationship — so if $5,000 could break you financially, don't lend it. Even the most well-meaning person can fail to keep a promise during difficult times. Ask yourself if that's okay with you. If not, don't borrow.
Consider the effect
When you lend money to a family member, it affects just about everyone you are related to. If you lend one family member money and not another, it can be a wedge for your relationships. Other family members may see favoritism, so think seriously about how going ahead with the loan will make others feel.
Make sure you get full details
While you may be afraid of hurting a loved one's feelings, you need to know where your money is going and decide if it's worth a loan. A bank would never blindly hand over money without knowing what it is being spent on, and neither should you. If the person gets offended, take it as a red flag that it's not a deal to make. And when you get details, follow them up. For example, if a friend asks for a few thousand dollars for a down payment on a house, review the house, costs, neighborhood comparisons, and how a down payment will affect the mortgage. Research all these variables before making a decision.
Charge interest Asking interest from a family member or friend may seem unnecessary, but it's the best way to protect yourself. Not only will interest inspire the family member to pay you back on time, but it can also protect you. For larger loans, talk to an accountant about what to do to protect yourself.
Discuss the conditions
Talking about money with family members can be tricky, especially if you're in a position to borrow. But going through the details could hurt both of you. Before you give the money, make sure you clarify the amount to be borrowed, the interest, the repayment schedule, and what to do if the person can't repay. Making the terms public reduces the chance of future miscommunication or confusion.
Put it on paper
Although a verbal agreement is considered legally binding, it still comes down to your word against someone else's - and even if you trust that person to abide by the terms you've made, you have no written agreement does not have a leg to stand on. Having written details that both parties agree to is also a good tool to avoid misunderstandings. Should legal action ever be necessary, a written contract will protect you much more than just a handshake.
Imagine the worst possible scenarios
While discussing loan terms may seem odd, you still need to consider the worst possible scenarios. Sit down and talk about what would happen if the person pays late or doesn't pay at all. You need to talk about an action or plan, whether it be extra costs for late payment, a collection process or legal action. This sets the standard for the business relationship so you both know what will happen if the deal fails. While it may not stop hurt feelings, it should eliminate any surprises if the borrower eventually defaults.
Stand away
One of the biggest mistakes you can make when lending to friends and family is wanting to take care of that person's financial affairs after you make the loan. Once you've agreed, you no longer own the money you're lending – obsessing over how it's spent will only cause problems. Separate yourself from the money and focus on repayment, not how it is spent.
When to say no
If you are not comfortable with the relationship, it may be in your best interest to decline the loan request. Money can be a serious force in tearing friendships and family relationships apart, so trust your instincts and just refuse if you feel uncomfortable. You may be able to help in other ways:offering a small cash gift, grocery shopping, or finding other ways to help. If you decide that borrowing money isn't the right way to do it, give some tips on what to do.
