Putting your friendships at risk by lending money to loved ones is never a good idea. It’s not easy to say “no” to someone who’s pleading for assistance in a time of need. Financially and emotionally, this is a minefield. You should take precautions to protect your finances and your relationship before lending money to someone close to you.
How to Lend Money to Family and Friends
You don’t see yourself as a person who would lend money to total strangers, thus you wouldn’t go out of your way to do so. You may feel conflicted about whether to help a friend or family member who has their hands out for money.
If you follow these suggestions, you can lessen the potential impact on your finances and your relationships.
- Never say “Yes” on the spur of the moment.
Refrain from giving someone an instant loan. Reply using a delay strategy such as, “I’ll evaluate my finances and see whether it’s even doable right now.” However, I can suggest some other creditors who may be able to assist you in the meanwhile.
Then you may refer them to companies that offer personal loans, like SoFi, or to credit cards with low interest rates or cards for persons with negative credit. Hopes are high that they’ll be able to work out their financial difficulties with a different lender.
- You should only lend what you can afford to lose.
Gambling experts advise only risking what you can afford to lose. Likewise, loan to a close personal friend or relative is not a good idea.
When you take a look at your bank account, you may come to the conclusion that you really can’t afford to donate any money right now. There are costs and expenses that are unique to you and your budget that you must meet. You are not obligated to be a piggy bank for your loved ones, and there is no shame in saying “no” to a favor request.
Prepare yourself for the very real risk that you will never see the money again if you determine that a little loan won’t break you. Consider the loan a gift in your own mind. Don’t give your borrower the impression that you’re encouraging default by acting in such a way.
Never lend money to a friend or family member unless you are prepared to forgive them monetarily and emotionally if they fail to repay the debt.
- Plan a Loan Pitch Meeting
You should treat the loan as a business deal even while a portion of your mind treats it as a gift. You should provide the latter to the borrower with the stipulation that they do the same with it.
If you’re willing to lend a friend or family member some cash, play the role of a bank and let them make a presentation for the loan. Meet at a neutral place, like a coffee shop, and instruct them to dress appropriately for the meeting.
Maintain a businesslike manner and treat them as though you were meeting complete strangers. Inquire as to the specifics of their financial need, and request proof if possible. If they need start-up capital, for instance, you should insist on seeing a thorough business plan.
Most home mortgage loan programs do not let any portion of the down payment to be borrowed, therefore it is important to know what scheme they want to utilize if they need assistance with a down payment.
Bank statements, credit card statements, and potentially tax returns should be requested if the candidate feels safe doing so. Ask for their SSN and credit history, then have them fill out a loan application.
When will this pretense end? Because your personal connection wouldn’t have the same ground rules as a business transaction. You should make it plain that they need to act in a borrower-like manner if they want to approach you for a loan. And one who is reliable and responsible. It also makes it easier to say no if you’re not convinced by their presentation or paperwork.
- Interest should be charged.
In a similar vein, it’s professional to charge interest on a loan. It’s possible that this might result in a nominal interest rate that is barely higher than the rate of inflation. It might also imply using interest rates closer to market rates in order to reduce opportunity costs.
Because you might get a good return on your money if you put it into the stock market, a house, or bonds. Lending money to your shady nephew at an interest rate of 3% while the stock market has historically returned 10% annually means you’ll lose 7%.
If you are put in the position of a bank, investing your money like one is a must. Someone you care about put you here, so they have no grounds for complaint if you treat the responsibility seriously.
- Charge Fees
Not only do lenders tack on interest fees, but sometimes they will throw on other fees as well. They’ll also hit you up for some cash. Both early payment (in the form of “points”) and overdue payment (in the form of “penalties”) are examples. The amounts and terms should be agreed upon in writing with the borrower.
A loan point is a one-time charge paid at the moment the loan is closed. One percent of the loan amount is represented by one point. Think about adding a point or two to the whole cost up front.
Though it’s not required, adding a fee to a purchase might make your loved one feel more like they’ve entered a commercial connection with you. In addition, a borrower’s accumulation of points makes them less likely to come to you for further loans in the future.
Designate a grace period and a late charge amount. Accept a late fee of 5% and a grace period of 5-15 days on all payments as fair. When lending money to loved ones, you should always impose a late fee.
- Accept the Terms of Repayment
Loan conditions need to be discussed as part of the loan arrangement. Among these are the repayment schedule, the payment schedule, and the method by which the borrower will return both the interest and the principal.
- Think About Taking Collateral
A close buddy once approached me for a sizable loan. I gave in, but only after he agreed to pay me many points in interest and give me his car’s spare keys as collateral.
He could have, in theory, tucked the automobile away somewhere I couldn’t recover it. But having the keys as security helped me relax a little. He ultimately repaid me in full, with interest, despite having previously defaulted on the payments.
Due to the fact that the owner won’t need it for transportation, high-value jewelry is a preferable form of collateral to a car. On the other hand, authenticating jewelry’s worth is more difficult.
The majority of people do not have anything of genuine value, such as a car or expensive jewelry. If they do, however, securing the loan with collateral will serve to further emphasize the fact that the lender-borrower connection is distinct from the borrower’s personal relationship with the lender. You’re not running a charity, and there will be repercussions for them if they fail to pay.
- Make a Notation
Promissory notes are binding contracts between a lender and a borrower. As thus, this agreement both guarantees and accepts the loan. A promissory note has the following details:
- The loan conditions
- The rate of interest
- The repayment plan
- All costs, as well as when they become payable
It also specifies the conditions under which the lender may retain any collateral that was pledged as security for the loan. Finding a note template online and editing it to your liking is a breeze. Having the loan agreement notarized is a great way to emphasize the severity of the loan to the borrower.
- Be open and honest with your family members.
The topic of finances often causes tension amongst relatives. The reaction will be predictable if you refuse to offer your less reliable son money when he comes knocking but give it to your more reliable daughter in a time of need. However uncomfortable it may be, it’s preferable than having to conceal family debts from close relatives.
Family secrets usually end up being revealed. And when they occur, they almost always result in some sort of emotional fallout. The need for openness in family affairs is justified.
Do not attempt to conceal loans made to family members. Have a family meeting if you have to. Ask your partner for their opinion and consent before making any large financial loans if you and your partner share your finances.
- Avoid micromanaging the borrower.
After signing a contract, you no longer have access to the money. If the borrower fails to make payments as agreed, you are within your rights to contact them again. However, you should not henpeck your borrower about their overall finances; instead, focus on inquiring about missed payments specifically.
Even if your intentions are good, you’ll only end up sowing the seeds of resentment. Put some distance between yourself and the loan and concentrate on making the payments instead of spending it.
- Take Caution When Cosigning
Instead of providing money themselves, some family members would cosign for their loved ones to assist them be approved for a loan or credit card. They believe they are safeguarding their assets.
Indeed, they are not. You still have to pay off the loan, and doing so might hurt your credit. Even worse, you can no longer determine the exact sum of your debt. Instead of borrowing just $1,000 from you, a family member may easily pile up $10,000 in credit card debt without your knowledge.
You should only agree to open a credit card in someone else’s name or cosign for a loan if you have complete faith in that individual. Cash is easy to manage, and borrowing or lending it won’t have any immediate effect on your credit rating. If someone else uses your name as collateral for a loan or line of credit, you will be responsible for paying off the debt.
- Be Wary of Tax Repercussions
You don’t need to file a gift tax return if you contribute less than $15,000 to an individual in 2021. If you lend more than $15,000 and the borrower fails, you must disclose the debt as a gift and pay taxes on the amount.
Interest-free loans make Uncle Sam nervous, too. Loaning a few hundred dollars won’t get you on his radar, but if you lend more than $15,000 without interest, the Internal Revenue Service may consider the interest you didn’t charge to be a gift. Charge at least the federally mandated minimum interest rate on loans over $100,000.
- Learn to Decline Pleasure from Family and Friends
Do not provide a loan to loved ones if you are unsure about your financial situation. Don’t put yourself in danger by using your own savings to bail out a friend or family member who has run into financial trouble.
Is it a good idea to help out loved ones by lending them money? There’s a good chance that it won’t. However, despite the wisdom of conventional financial counsel, there are occasions when interpersonal connections are more important.
You should lend money to a loved one only if you can rationally justify the expense. Put in the effort, be ready for the worst case scenario, and try to keep the personal aspects of your new lender-borrower relationship out of it.