Five Key Rules To Follow When Lending Money To Friends And Family

Five Key Rules To Follow When Lending Money To Friends And Family

Getting hit up for a loan can make you feel like you’re stepping into a minefield. In today’s economy, it’s easy to understand how someone can find themselves in a dark place financially. On the one hand, you want to help out a loved one who’s in need.

On the other hand, you’ve heard the stories about loans gone wrong, with friendships ruined and families torn apart. Also, you may be depleting funds that you might need yourself, says Irene S. Levine, PhD, psychologist, author and producer of TheFriendshipBlog.com. Even if you’re sure that the asker will pay you back, it’s hard to know if you should proceed.

This article originally appeared on LearnVest.

To help guide you toward making the right decision, we asked financial experts to share five key things to consider before cracking open your wallet.

Rule 1: Only Say Yes If You Mean It

If you feel guilt-tripped into making the loan by the asker (“I’m desperate!”) or you question your own hesitation (“I must be a bad person or I wouldn’t feel conflicted”), then turn her down, says Levine.

If you do cough up the cash when you aren’t sure you want to, you risk feeling resentful, and that can cripple the relationship before it’s even time for her to repay you. Not going through with the loan doesn’t make you selfish or a bad friend; the response may actually protect your bond, she adds.

Levine suggests graciously declining with a sentiment like, “I’d really like to help, but I don’t have the extra money to loan right now.” If you feel like you need to explain further, mention an unexpected expense you were recently hit with, such as higher health insurance premiums, or something you have to save for, like your kids’ education.

Offering to help brainstorm other sources for the loan or ways to bring down her debt (if that’s the situation) can be a thoughtful next move. A true friend or relative will be willing to accept “no” and then thank you for any additional help. If she doesn’t, better that your relationship sours before you’ve forked over any funds.

Rule 2: Lend Just What You Can Afford to Lose

Your friend or family member may check all the boxes for being trustworthy, financially stable and reliable, but “things can happen that prevent them from paying you back as originally planned,” says Byron Ellis, a Certified Financial Planner (TM) and managing director at Ellis and Ellis, a division of United Capital Financial Advisers in The Woodlands, Texas.

If your loanee does get in a bind, a best friend or family member is going to be relegated to the end of the payback line, “behind the mortgage company, the credit cards, the auto loans, etc.,” says Ellis. Now, imagine your stress level and the tension that would rise between you both if you actually needed that money — and she couldn’t repay you.

Bottom line: Be prepared for the worst by giving only an amount that, if never returned, wouldn’t jeopardise your own savings goals, bill-paying ability or other relationships.

Rule 3: Create A Firm Repayment Timeline

Ten years ago Emily White*, 43, lent her younger sister $20,000 to buy a house near their elderly parents, without discussing a repayment date for the loan. “I loved that my sister would be there for my parents, and the idea was for her to pay me back once she got settled and found a new job, since she had moved from out of state,” recalls White.

But as it turned out, White’s sister appeared to have another idea in mind. “Now she’s been working for years, yet she hasn’t mentioned anything about payback,” says White. “I had no idea we were on a 10-years-and-counting plan. I wouldn’t be upset, but now I’m considering some investments and that money would help.”

White’s mistake was thinking she and her sister were on the same page when it came to repayment — a situation that could have been avoided if she had a thought-out plan.

It might seem too businesslike, but “set specific terms for the loan that everybody can agree to,” says Ellis. “Discuss how much money will be loaned, interest rates and how long they will have to pay it back.” This way, she’ll know when she needs to come up with funds, and you’ll know when the money will be back in your account.

By nailing down this schedule, there’s also no mistaking this money as a gift, adds Ellis. The loanee also can’t postpone repayment indefinitely and claim she didn’t know you needed it so soon.

As Ellis mentioned above, it’s also wise to charge interest and work that into your repayment schedule. Depending on the amount, loaning money can involve complicated tax rules; failing to charge interest might get you in trouble. To avoid this, you may want to charge the borrower the income tax rate as interest.

Rule 4: Always Put the Loan in Writing

Memories fade, priorities get shifted and clashing opinions over what you originally agreed to can cause problems between friends or family, says Priyanka Prakash, a finance specialist at Fit Small Business and a former business attorney.

Another benefit to having the amount and conditions in writing: Drawing up an official loan document makes it more likely that the borrower will take the loan seriously and pay it back on time. “So if you miss a payment, this is the piece of paper that we’ll look at that will help us to decide what to do, so it moves the friendship out of the way,” adds Ellis.

When registered nurse Lisa Schloeder, 49, decided to help a colleague enroll in a nursing assistant program, she wanted the $1500 loan agreement on paper. “I saw this woman at the office every day, but I still thought it was best to put everything in writing to make sure we both understood what we were getting into,” remembers Schloeder.

Her foresight paid off. “There was a check waiting for me every two weeks as we had agreed, and I felt great seeing what an amazing nursing assistant she became for our practice,” she says.

You can draft a simple personal loan agreement without hiring an attorney, Prakash says. But more complex deals — for example, if they involve collateral or involve more than $10,000 — may require a lawyer to be involved.

Ideally, a loan agreement should be dated and state the loan amount, due date for paying it back in full, the payment schedule and any agreed-upon late payment fee (see Rule 5) or interest. Full contact information for the loaner and borrower and both of your signatures, either handwritten or electronic, are important, says Prakash.

If loaners need help pulling a formal document together, they can opt to search online for a promissory note template, which states the promise to pay someone back and can help ensure that all the important details are covered. In most states a promissory note just needs to be signed by the borrower to be valid, but it’s better if you sign, too, so that the intent of both parties is clear should you have to go to court, Prakash says.

Rule 5: Never Let the Due Date Slide

If your dinero doesn’t show on time, ignoring the lateness or making excuses for not confronting the borrower would be a mistake. She might continue going along as if the due date you set is a loose guideline rather than a rule.

Make it more businesslike, so neither of you feels like you’re taking advantage of the other. “I did this the last time I lent money to a friend,” says Ellis, who suggests putting details about a late penalty in your written agreement; a friend would have to pay the penalty on top of the regular payment. This tactic would hopefully save you from having to send reminders… and save you from regretting your decision to play banker.

A five-day grace period, says Ellis, is reasonable before hitting your friend with the fine, since things do happen. If signs are pointing to more serious delinquency — a number of scheduled payments have been missed and numerous follow-up emails or phone calls from you are ignored — it might be a good idea to consult with an attorney. “If the borrower still doesn’t pay, you can take them to court,” says Prakash.

In the scenario where one lump-sum payment is being paid back after a long-term loan, it never hurts to send a reminder email a month in advance of the due date to show her that you’re sticking firm to the terms. For example, “According to the agreement we signed, the loan I gave you will be due on June 15. I’ve attached an original copy, in case you’d like to refer to it. So glad I was able to help my cousin out.”

*Names have been changed.

The Golden Rules for Lending Cash to Close Friends or Family [LearnVest]

Image by Julia Tim (Shutterstock).


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