How To Lend Money To Friends And Family
Lending money to a friend or family member can often result in loss of money and loss of the relationship. But when someone you love is in a serious bind, and you have the means to help them out, it can be almost impossible to say no.
So when someone asks to borrow money, take some time to consider your answer.
Don’t ever apply for a credit card in your name for someone else, unless you are both on the account. Think carefully before co-signing a loan. Don’t put yourself in a position where someone else’s actions could prevent you from obtaining credit in the future.
Think of lending money as if it were gambling – only loan out what you can afford to lose. Don’t rely on monthly loan payments as part of your income.
One of the first questions you are asked at a bank when you are applying for a loan is “what is the money for?”. If you’re going to lend money to friends and family, it should only be for emergencies. Ask them what the money is for, and if they get offended, don’t do it.
Does the person have the capacity to pay the money back? You need to know all their income and all their expenses, and from that make an educated decision on their ability to pay. What other avenues has the person sought out?
Terms and conditions
This situation is already awkward enough, but you still need to make the terms clear. Is it a “payday loan”? If so, the loan needs to be repaid on the next payday. If it is a larger sum of money, regular interest (or not) and principal payments need to be made.
Get it in writing
Make sure you draft up a promissory note, especially if the loan is a larger sum of money. Many websites allow you to draft up a note for free (I use this one).
If the loan is a larger amount, I recommend you look at securing collateral (something of value that could be held until the loan is repaid), and also get a witness. On the promissory note templates like the one I linked above, there is a section you can add which allows a signature of a witness. It’s just an added bit of security in case things go south.
Think it through
Consider the impact on your relationship with this person, and others around you. For example, you just said no to your Nephew when he asked for a loan, but a week later you say yes to your Niece when she asks for a loan. Make sure your decision is not perceived as favoritism.
If you’re lending family money, make sure all relevant parties are on board, i.e., your spouse.
What if you die before the loan is paid back? Is the loan forgiven? Owed to the estate?
‘No’ is an acceptable response
If you’re not comfortable loaning money to the ‘applicant,’ you should just say no. Don’t leave them hanging. If you don’t want to do it, say so right away so they can look at other options. Trust your instincts.
- Don’t become the go-to lender in your family. It might have worked out for you once, but you may not be so lucky next time.
- Don’t dip into your emergency fund or retirement savings. What if you need the money in the future? You may end up being the one needing a loan.