Lending Money to Family and Friends
January 7, 2009
We all know someone who has been hit hard by the economic downturn. Whether it’s losing a job, losing health insurance, or losing thier house many people find friends and family members in financial touble and in need of help.
Lending money to family and friends is a delicate mattter, this article from the Financial Planning Association takes a look at alternatives to lending them money, how you can help them make a plan to pay you back, and a few legal and tax considerations.
Plan the talk first: Remember that this situation is as much about the relationship as about money. The decision to help a family member with money problems requires understanding – lecturing tends not to work so well.
But it’s right to encourage the people you want to help to look at their financial situation and if they are in debt trouble of any kind, they should get help. It’s also important that you support them emotionally and have confidence that they will make it through this.
Consider whether you can make monetary support a gift: Actually, this is a good first question in any scenario where you offer help. What happens if you don’t get the money back? For the sake of the relationship involved, it might make sense to think through that possibility.
Would the potential loss of money injure you, and worse, will it injure the relationship? If you don’t think you will be repaid would you be willing to consider it a gift?
Making your support a loan: There are good and bad aspects to private loans. The good news first:
- Terms can be significantly friendlier than what a borrower would qualify for in the open market. For example, the interest rate you charge on the loan can be lower than the borrower would pay a commercial lender.
- You can require little or no collateral. You may also choose to require little or no collateral, and you may want to extend the repayment period longer than a bank normally would offer.
- It’s a way to keep money in the family.
Remember, if you ask a lower interest rate, you need to understand that you are making a gift to the person of the amount of the “forgiven” interest. This amount can be deducted from the annual gift exclusion limit.
Downside to private loans: A poorly written agreement can lead to missed payments or default. For example, if the borrower dies suddenly, the lender’s investment may be lost if the agreement isn’t structured correctly. A properly executed promissory note is still an obligation of the estate, and may continue to be paid to an heir or other person or entity based on the terms as agreed. In addition, relatives cannot say they weren’t treated fairly.
One alternative to lending the money yourself is to help them get started with a loan listing on a peer to peer lending service like Lending Club.
The best arrangements are formal: Lending agreements should be written in proper legal language, notarized and recorded in the county where the property resides. A financial planning professional can talk to both parties about what such loans – particularly real estate loans – can mean for their respective finances.
One service that can be used is Richard Branson’s Virgin Money, a social lending organization that helps facilitate loans between friends and family, they can help you with the correct ways to document the loan transaction over time for tax purposes.
Are there nonfinancial solutions? There are other solutions besides writing a check. You may consider opening your home to family if they lose their housing or helping them maintain their home if they can’t afford much beyond their mortgage and other bills.
These are not small decisions and will lead to some financial sacrifice on your part – rising utility and food costs will increase your burden. You’ll definitely want to revisit your household budget before you make this commitment.
Help them set a plan: No matter whether you offer a gift or a loan, you might want to work with them to develop a plan that will either return the money to you or put them back on their feet, or both.
Set an endpoint: The thing about blending unconditional love and money is that it can be tough for both parties to move on. It might be wise to set a particular endpoint for financial support at the beginning so both parties know the clock is ticking on a solution.
If you’re providing housing, loaning a car or providing some other non-financial support, it also makes sense to put an expiration date on that assistance so it doesn’t become a permanent situation.
Have friends or family come to you for financial assistance? How have you handled their requests for help?
Ben,
Thanks for the Lending Club mention. I think for me personally, all other options should be looked into first before lending or borrowing from family members. The problem with money is that it can change the dynamic of relationships, and that isn’t something you usually want to mess with.
Lesson: send them to Lending Club first : )
Regards,
DK
Product Ambassador
lendingclub.com
Lending money to friends and family is almost always a bad idea. Sometimes it works out but overall it isn’t worth it. I would try all other options before asking family for a loan. I would be more likely to give someone a large gift than give them a loan for the same amount.
I’ve been blessed with a large family and good income. This means family members have looked at me as a source for “bridge” money to help them in whatever situation.
Even though they seem like small amounts, $3K here, $5K there, $1K further there can be a strain, and you have to say no at some point. I think services like Lending Club and Virgin Money are great ways to make these agreements and create a sense of formality. Thanks for bringing them to my attention. I will be looking into these options moving forward.
My #1 rule is never lend more than you can afford to lose.
My #2 rule is an understanding that there will be no more loans, ever,
if this one is not repayed.
So far, all loans have been repaid.
My loans are small amounts, under $1000,
and to my kids only.
My personal rules
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I found myself in a difficult position after I loaned one of my friends my credit card to cover a couple of misc. expenses he was expecting at a concert he was going to. I didn’t know that he can’t handle money and that he was hiding a gambling problem/addiction. He attempted to get cash advances from the CC and was ultimately successful after repeated attempts. Even though I’d not set up a PIN for the credit card, somehow the issuing bank allowed him to withdraw sums of money. I’ve written to the CC several times to complain, and they’re “researching” the problem.
When this episode is added to my friend’s other “loans” (to cover cable, phone & car repairs) I’m out over $3000! Way to ruin a friendship? He’s been doing handyman repairs around the house but I explained to him that I didn’t budget that much money for home repair and would prefer that he paid me back in cash.
That’s a lot of money for me to forgive and I’m having a hard time coming to terms with it. This friend can’t be trusted, that part is obvious. I don’t know what recourse I have, other then to notify his family. I’ve lost all respect for this man yet I pity him. He works a part time job and can barely make ends meet.
Does anyone have any suggestions? I did read up on my “savior” issues and can tell you that this won’t happen again.
The BANK o’Cheddah is CLOSED!
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At times couples are squabbing over money matters and their relationships affects
a lot because of this. i too was one of the victim to this and i was adviced by one of my friend to get rid of this and i did …
i thought the same way as you did a few months back when i and my partner had some issues on money matters and our relationship seemed like it is gonna sink
and i went into depression and only on one day my friend made me realize how i could overcome my issue with this.
And it worked for me and now, we are a happily living couple.