Lending money to family or friends seems like a simple gesture. Helping out might be even more critical these days. A recent article quoted someone who said they have only $4 in their checking account. Your family members or friends may have lost income due to the coronavirus pandemic. Now, as the holidays approach and they face end-of-year financial obligations, they might ask you for help.
In some ways, lending to a stranger is easier. The element of familiarity is missing. Most financial experts will tell you not to loan money to those close to you. It’s not a step you should take lightly. But, if you think you might want to give a loan, here are five tips for lending to family or friends that will help you keep your relationship intact and protect your financial health.
1. Exhaust Other Possibilities
Before jumping in with your own money, see if you can help them get the funds they need from a lender. Providing monetary assistance to family or friends can be stressful, and you risk hurting a close relationship. It might be better to co-sign a loan application. Guide them through the process of accessing loan funds from other sources, such as an online lender. Of course, you’re still on the hook for the loan, so you’ll want to be sure they can pay it back.
Does everyone in your family have different tastes in cuisine? This can be a great chance to create memories by holding an annual family contest in which the winner gets to choose what the family eats for Christmas dinner. You could decide the winner based on who put in the most volunteer hours with a favorite charity, or maybe a family game of Monopoly is more your speed.
Even if you only do this one time, everyone will remember the Christmas dinner when they had pizza and wings with their eggnog.
2. Can They Repay the Loan?
Everyone needs to be realistic about the ability to repay the loan.
- RetirementIs the money to cover an unexpected expense? Or have they gotten into trouble because of poor management skills?
- How much debt are they carrying?
- What is their monthly income?
- Ask to see a budget. If they don’t have one, help them create a realistic accounting of their income and expenses.
- Identify where the money will come from to repay the loan.
3. Can You Afford to Cover the Loan?
Don’t go into debt lending money to your family or friends. Even with the best intentions, they may not be able to repay the loan.
- Do you have enough saved up in your emergency savings account to cover a default?
- Are there any large payments on the horizon, such as a balloon payment? Will you be able to cover it if you’ve made a loan?
- Will the loan put a strain on your finances and standard of living? If so, you might come to regret your decision or feel resentful.
4. Lending Money to Family or Friends: Put Everything In Writing
You might think that because you are family or close friends, a verbal understanding is sufficient. But, it’s easy to forget details, especially when it comes to paying back a loan. There could be a difference in memories, setting you up for unnecessary conflict.
Putting everything in writing makes the transaction serious. At a minimum, include the following:
- How much will they pay every month?
- What is the deadline for repaying the loan in full?
- Will you charge interest?
- What if they miss a payment? Will you charge a late fee or penalty?
- What action will you take if they default on the loan?
Keep a record of all payments. Provide receipts. It doesn’t have to be fancy, a simple note with the date and amount paid, and your signature. Retain a copy for yourself and give the original to them.
If it’s a large loan, you might want to ask an attorney to write up the agreement. Or to at least look over the loan agreement you have prepared.
If you’re lending money to family or friends, you might think that you now have a right peer into all of their affairs. Loaning money isn’t a license to run their financial life. Trust in the process. Give space and allow the borrower to feel good about honoring their commitment to you.