“What’s up Uncle Bob? Hey, my car won’t start and it turns out I need $1,200 for repairs. I only have $200. Can you loan the rest to me? I’ll pay you back.”
For many of us, this is a pretty familiar scenario: a friend or family member who is faced with an unexpected expense asks to borrow money, resulting in an often uncomfortable situation. If I don’t lend the money, what will my son do? Will he lose his job/car/house? And if do lend the money to him, what then? What if he doesn’t pay me back?
The Golden Rules of lending
If you’re thinking about whether or not to loan money to someone, here are some general rules of thumb to consider.
As the old gambling saying goes: “Never bet more than you can afford to lose.” The same is true for lending money. It’s also good practice to think about what would happen if the person doesn’t pay you back. Even the most well-meaning person may fall on hard times and default on the loan. So if being out $6,000 would put you in a bad situation financially, don’t lend it.Consider the bigger picture
When you lend money to a family member, you impact just about everyone else you’re related to. “He loaned money to John, why didn’t he say yes to me?” Lending to one family member and not another can strain relationships. If you’re loaning money to one of your children or grandchildren, it’s a good idea to call a family meeting and discuss it openly to avoid any confusion or hurt feelings.
The devil is in the details
Ask what the loan is for and the circumstances behind the request. It’s not being nosy; a financial institution wouldn’t blindly hand over funds and neither should you. If the borrower becomes offended, or won’t provide information, it’s a red flag that you should turn down the request. Once you know what the loan is for, it’s time to talk details. Clarify the amount being loaned, the repayment schedule, and the penalty fee for late/missed payments, if applicable.The opposite is true after you dole out the loan. Don’t micromanage the person’s spending. Once you’ve agreed to and sealed the deal, distance yourself and accept that the money is no longer in your control. Focus on repayment, not on how the money’s spent.
An interesting development
Charging interest to a relative or friend might seem extreme, but it’s the fairest way to protect yourself and your money. A reasonable interest rate can help inspire the borrower to pay you back in a timely manner, and also protect you from being charged gift taxes. If you lend more than $13,000, you’re liable to pay a gift tax on that amount if you don’t set a loan with reasonable terms and get it in writing. For large loans, it’s a good idea to consult with your attorney or accountant.
Get it in writing
Although a verbal agreement can be legally binding, it often comes down to he said, she said. Draw up an agreement stating the terms of the loan (called a promissory note), have both parties sign and get it notarized. Not only will having the details in writing help prevent misunderstandings, if it comes down to it, a written contract will protect you in court.
To co-sign or not to co-sign
Sometimes the request is not for money, but for you to co-sign a loan. Basically, a co-signer, or guarantor, is someone who agrees to pay the loan if the borrower defaults. This can be helpful if that someone is your son or daughter is and they are just starting out with little or no credit history. However, it can also hurt your credit.
The loan will show up on your credit report and increase your debt-to-income ratio. This could lower your credit score, and make it more difficult to obtain your own loan if you should need one. Also, any late or missed loan payments will be negative marks on your credit report. Keep in mind that you will be a co-signer for the life of the loan, unless the borrower refinances and removes you. Be sure to really think it through before signing on the dotted line.
If you do co-sign a loan, it’s good practice to regularly review your credit report.
If the answer is “No”
If, after weighing the pros and cons, you decide you just don’t want to lend the money, say no. If you have difficulty denying the request of a loved one or friend, try one of these softer, yet direct, approaches:
- “Sorry, but I’m just not in the financial position to help right now.” Or, “Sorry, it’s not in my budget.”
- “I don’t feel comfortable lending money to friends or family; I’ve lost/damaged too many relationships this way.”
- “I paid for your last house repair, and you haven’t paid back the money. I can’t do it again. Sorry.”
You can offer to help out in other ways. Maybe you can buy groceries, give a gift card or cash gift, make meals, offer rides, help organize a fundraiser, donate items you’re not using that can be resold, or help watch the kids to cut back on childcare costs.
References: Moneycrashers, Money Talks News, U.S. News & World Report