Family Loans: How to Lend Money to Family and Friends and Not Regret It
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It's amazing to be able to help a friend or family member who is facing financial difficulties, but money has a way of causing misunderstandings and hurt feelings. Many financial gurus advise against lending money to family members. 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. However, each scenario is unique. It's critical to consider all of the factors before making a decision.
If you’ve decided to make a loan, follow these tips to make sure you don’t end up regretting it:
Consider making the loan a gift.
There’s less chance of ruining the relationship if there's no expectation of being paid back. But here’s the thing, it doesn't make sense to put yourself in a financial bind so make certain that you can afford it. Keep in mind of the gift tax though so you’re following the IRS rules.
Avoid lending additional money.
If they couldn't pay back the first loan, the chances of paying back a second loan aren't any better. It's a good idea to get all of your money back before allowing someone to borrow more money from you.
Poor financial practices have caused many people to face financial difficulties. So in some instances, a loan is unlikely to really help someone because they aren’t learning from the situation, they’re just throwing more money at it. Learn to say no, and offer no explanation about it.
This is called setting boundaries. If you’re struggling with telling people “No”, read this book, Boundaries by Henry Cloud and John Townsend. I started reading this book and it changed my life.
Create a loan agreement.
The loan will feel more formal with a document, and your friend or family member will be more inclined to take it seriously. If you need to take action to obtain your money back, having some documents will undoubtedly assist you.
Be clear about your expectations.
Your borrower will realize the importance of being responsible if you make it obvious that you're delighted to help but it's also crucial that you're reimbursed. Be upfront and honest about how important it is to get your money back.
Consider a peer-to-peer lending tool.
Personal loans can be administered using Peer to Peer Lending websites. The payments are tracked and reminders are sent out by the program, not you. So if these conversations about “Where’s my money?” are too uncomfortable for you, you may want to consider this option. Although this increases the loan's cost, your borrower will be notified if they fail to make a timely payment. You're not even required to do the nudging!
Here are some Peer to Peer Lending sites:
Read more about peer to peer lending here.
Charge some interest.
Although it may appear cruel, charging interest provides a number of advantages. It communicates to the borrower that you are serious about the loan. By making it obvious that it's a loan, it also eliminates any potential gift tax. For family loans, the IRS has interest guidelines. Be sure to check the AFR Rulings to learn more.
Consider what you’ll do if you don’t get paid back.
If you made it clear that it wasn’t a gift, what will you do? How will you feel? The answers to those questions might change your mind about loaning them money. Are you willing to just let it go? Are you going to take them to court? These are questions you really have to ask yourself because you’ll need to follow through with whatever decision that is.
Just say “no.”
In some instances, refusing to loan them the money might be the wisest option for everyone involved. If you truly need to be paid in full and fear the borrower will not fulfill the arrangement, it may be better to disappoint them rather than putting yourself into a financial bind.
Final Thoughts
Lending money to friends and family is a thoughtful gesture, but it comes with risks. Personal loans are untrustworthy. Communication is crucial if you decide to loan money to anyone. For the best experience for everyone involved, make sure that everyone understands the details.
