When a family member or close friend has come to you looking for a loan, what should you do? You’ve probably heard horror stories about how money and family don’t mix. However, it can be difficult saying no to someone you care about in their hour of need.
So, before you write someone a blank check—or shut the door in their face—check out these tips for lending money to a friend or family member safely and responsibly.
1. Ask A Lot of Questions
Before you say yes or no to anything, you should hear someone out – but also ask plenty of questions. You should know exactly why your friend or family member needs money and what they’re planning to do with the money you give them.
If someone is unwilling to tell you their plans for your money, you shouldn’t give them anything. Ask plenty of follow up questions about their plans for using your money, and their strategy for paying you back.
If the person can’t provide answers or doesn’t have answers that make you feel comfortable, it’s okay to say no and explain that you have concerns about their plan (or a lack thereof).
2. Think of Alternative Ways to Help
For people in need of a loan, asking a friend or family member is usually one of their last options. However, it doesn’t hurt to think of ways to help that person without loaning them money.
Maybe there’s another loan source that person didn’t consider before coming to you. Perhaps you can help that person put together a budget that can improve their financial situation. You might also be able to help them find a job or a side hustle that can help their financial situation without hitting you up for a loan.
Exploring every possible option with someone is also a good way to learn more about their financial situation and their ability to pay you back. And all without making them feel like they’re being interrogated.
3. Consider the Consequences
Before you say yes to anything, make sure you understand the risks. A lot of people lose friends or never speak to family members ever again because of disputes over money. You need to accept the possibility that this person might not pay you back. Can your relationship survive that? Could you maintain a relationship with this friend or family member if they never pay you back? Will you hold it over their head for the rest of your life? These are questions both parties need to consider – especially if the money exchanged is a significant amount.
4. Only Lend What You Can Afford
This might be the most important rule on our list. You should never lend anyone money if there’s a chance doing so could get you into financial trouble.
As we touched on in the previous section, you should assume that the money you lend will never be paid back. If you have a lot of money in an emergency fund or stashed away for a rainy day, you might be able to loan some out to a friend and be fine if you never see it again. But if you’re dipping into your retirement fund to lend someone money, or doing so will prevent you from making an investment elsewhere, you’re better off saying no.
It won’t be easy, but you have to make sure your finances are secure before helping other people with their money needs.
5. Make It Cash Only
If you can afford to loan someone money, that’s great, but make it a cash-only proposition. Co-signing a loan or giving someone a credit card in your name can be worse than loaning someone money that’ll never be repaid. These kinds of things can end up hurting your credit score if things turn south. Losing money is one thing, but damage to your credit score can have long-term consequences for your financial security. If a friend or family member asks you for anything other than a cash loan, you have to put your foot down and say no.
6. Charge Interest
Obviously, you’re not a bank, but if someone is going to treat you like a bank, it’s okay to act like one by charging interest. If you’re upfront with someone that you expect to be paid back with interest, they’ll be less likely to take advantage of you by never paying you back. You don’t want to gouge someone you care about with the kind of high-interest rate traditional financial institutions might offer. However, you can treat it like an investment with the hope of getting back more than you put in – while also holding that person accountable.
For large sums of money, you’ll actually be obligated to charge interest if you loan money to a friend or family member. As of 2019, you are subject to a gift tax if you give someone more than $15,000 in a given year. The only way to avoid paying this tax is to charge that person an interest rate that’s on par with the Applicable Federal Rate that’s set by the IRS every month. Even if your loan to a friend or family member is less than $15,000, charging at least a little bit of interest can be a good idea.
7. Write Out the Terms
Even if you loan money to a friend or family member you trust, it’s still best to have everything in writing. Technically, a verbal agreement would be legally binding, but it’s best to have a written agreement signed by everybody involved in case the loan isn’t repaid and you need to take things to small claims court. You need to write down how much money is being borrowed, the repayment date, interest rate, and late fees that will be charged.
Obviously, this doesn’t show a lot of trust in your friend or family member. But if they need the money, they should be willing to sign a formal agreement.
It might sound unnecessary. But if things don’t go according to plan, you’ll be glad that you wrote out the terms of the loan and made the agreement official, even if you don’t end up pursuing legal action.
8. Create a Payment Schedule and Track It Closely
Again, this is something a bank would do and something you should do if someone asks you to loan them a significant amount of money. If nothing else, you should create a spreadsheet with payment dates and amounts so both of you know when payments are expected and track when they’re made.
You should also make it clear that there will be penalties added if payments start coming in late. Of course, the payment schedule should be reasonable and within the borrower’s budget. But you still need to make sure you keep track of the schedule so payments are made on time. It will also help to receive payments in the form of a check or electronically; using cash makes it harder to track and could lead to disputes.
9. Be Patient
If you’re going to lend someone money, the best thing you can do is be patient and take a hands-off approach. This is why it’s best to set up a formal written agreement and pay schedule. Pestering someone about the money they owe you is only going to lead to problems and unnecessary tension in your relationship. You’re not Tony Soprano.
It won’t be easy, but you need to do your best to keep the money separate from your personal relationship. Avoid asking questions about how your money is being spent and when you’re going to get it back. Remember, when you chose to lend it, you decided you could afford to do so and have faith the borrower will pay you back. Be patient and trust that person; if you can’t do that, you shouldn’t make the loan in the first place.