According to the Federal Reserve Board Survey of Consumer Finances, over $89 billion is loaned annually between friends and families in the US. It takes a lot of courage or desperation to ask for money, so before you decide whether to lend it to them, consider how it may affect the relationship.
If you are trying to decide whether to lend money to a friend or family member, read on for tips on what you should consider before you make a decision.
If you’ve already lent money to a family member or a friend and have trouble getting it back, read our tips on how to collect personal loans.
Before You Decide
1. Assess the Relationship
Before lending money to family or friends, think about how it may impact your relationship in the long term:
- Will the debt affect the quality of your relationship?
- What happens if they can’t pay you back?
- Will it create a rift between you?
- How will you deal with it when this happens?
- How can you ensure the loan doesn’t create a power imbalance that fuels arguments in the future?
- If they’re a close friend, how will you ensure you will recover the debt without needing to remind them every time you see them?
- Does the money mean more to you than the relationship?
2. Understand Their Financial Situation
Understanding what they will use the money for is extremely important, depending on the context and the borrowed amount. Consider the following:
- What is the money for? Is it for essential needs like school fees, mortgage, or car repairs?
- Could the money be used for harmful habits like gambling or undisclosed addictions?
- Can they realistically repay you by a specific date or in installments?
- Do they have a clear understanding of their financial status to avoid further debts or extensions?
Before lending them the money, speak to their family members and see what information you can gather.
Understanding their financial situation can also help determine their capacity for repayments. They may feel like they can pay you back at the time, but in reality, they might not have a clear picture of their finances and might require extra loans or extensions.
3. Assess Your Finances
Ensure you are in a financial situation to lend money to others before you do so. Ask yourself the following questions:
- Is the loan amount small enough not to affect your living standards, mortgage, or quality of life?
- Can you afford to lend the money without expecting repayment (especially for substantial amount)?
- Are there any upcoming expenses or events that may require your financial resources?
Perhaps the loan is only for a small amount, which won’t affect your quality of life, mortgage repayments, or living standards. On the other hand, suppose the loan amount is for a few thousand dollars. In that case, you may need to assess whether or not you can afford to give the money away in the first place.
In some cases, you may be better off loaning them the money and receiving regular repayments, as it may allow you to manage your cash flow better.
How to Say No
Take Your Time
Before saying no to your friend or relative, take some time, say a day or two, before replying to their request. If the loan isn’t highly urgent (e.g., a hospital emergency), it might give the borrower time to find other funding sources.
Giving yourself some time will also enable you to assess your financial situation and, if necessary, find the funds you’re lending.
Be clear and direct about why you can’t lend them money.
For example, “I’m so sorry, but I have to pay my phone bill this week, so I can’t lend it to you.” This will enable them to understand your financial situation and realize that you cannot lend them the money right now.
For example, “Have you tried Uncle Sam? He might have some money he can lend you.” Or you could suggest, “Maybe you could have a garage sale?”
Always remember this person is reaching out to you for help if you can’t provide them with money; at least guide how they can solve their financial problems. You could also visit a financial planner with them if you feel it could help.
Don’t Feel Guilty
Everyone handles money differently, and we all have different income levels. Perhaps you cannot afford to lend them the money right now. Don’t feel bad. And don’t allow them to make you feel bad. Although you may be better at saving or paying off your mortgage repayments, you don’t need to feel guilty that they are not as savvy with their money.
If you have the means, then, by all means, loan it to them, but if you don’t, then you don’t. Don’t dwell on how bad you feel for the other person, as this situation could also serve as a lesson they need to learn in managing their finances in the future.
Uncover Potential Issues
Help them manage their money better. If you can’t loan them the money, you can consistently offer to help in managing their finances.
- Are they living beyond their means?
- How are they balancing out their income with living requirements?
- Are they always worried about money? Why can’t they make ends meet?
- Are there ways they can avoid being in this situation again?
In addition, pay attention to this person and try to read between the lines if you can. What are the underlying issues that might be recurring?
- Do they have an addiction that needs to be addressed?
- Where can they save money in their day-to-day spending?
- Do they need to have a look at their position at work?
- Are they being paid enough? If not, and there is no clear pathway for a pay raise, how can they generate more capital through secondary sources of income?
Working through these questions with your friend or relative can assist them in sustaining their finances in the long term and hopefully save them from needing to borrow money again in the future.
How to Say Yes: Leave a Paper Trail
Reminding people of their debt might feel awkward, whether they are close friends or distant relatives. When you are lending anyone money, it is advisable to leave a paper trail of the transaction and some legal documents alongside the repayments made.
Depending on the amount borrowed, you should request the borrower sign a written agreement stating the repayment terms, including the amount owed and the date the borrowed amount must be repaid.
Can I charge interest on the loan?
When lending money to family or friends, charging interest is legally permissible but can complicate relationships. Consider the emotional impact and potential legal implications. If you decide to charge interest, ensure the interest rate is reasonable and clearly communicated. Remember, the goal is to help, not profit, from their financial need.
You can choose to use either an IOU form, a promissory note, or a loan agreement for a loan with more complex terms. All three of these forms will enable the transaction to be traced and used as evidence in court if there is a discrepancy between you.
► READ MORE: Loan Agreement vs Promissory Note
Looking Beyond the Loan
In conclusion, lending money to family and friends is a decision that requires careful consideration. While it can provide immediate financial relief, it’s important to recognize that it may only be a temporary solution to a deeper, long-term problem.
Rather than simply being a financial source, consider playing a more supportive role in their journey towards financial independence. Offer guidance on budgeting and financial planning, helping them develop skills for managing their finances more effectively.
Remember, the ultimate goal is to empower your loved ones to overcome their financial challenges, not just provide a quick fix. By doing so, you contribute to their long-term well-being while maintaining healthy and supportive relationships.
► READ MORE: The Complete Guide To Family Loan Agreements