We have all heard that it's a bad idea to lend money to friends and family. However, if you have the extra capital and there is a friend or family member in need it is sometimes hard to say no, especially if their situation is dire. You know you have the ability to turn things around for them, so doing nothing feels miserly. The fact is, many people DO loan money to family and friends. According to a 2013 survey by American Consumer Credit Counseling, 82 percent of Americans polled would let relatives borrow cash if asked, and 66 percent said they'd loan money to a friend.
If you are in a situation where a family member or friends needs to borrow money, the Rules of Thumb blog from MoneyThumb would like to help ease your mind about making a personal loan with the following 5 helpful tips:
- If Yes Is Your Answer, Ask Yourself Why--Many times we are wary of turning down a request to loan money because we're afraid of straining a personal relationship or being seen as selfish or uncooperative. But no relationship should be based on your yes or no answer. If it would hurt the relationship for you to say no, it might not be as strong a relationship as you thought. Another reason you may have for making a loan to friends or family is that it makes you feel like a hero. That’s an emotional choice, not a financially prudent one.
- Consider Alternatives--If you decline someone’s request for money, elaborate on the steps the borrower could take to resolve the situation themselves. For instance, if they need money to start a business and you don't feel strongly about putting your money up, offer some other suggestions, like the Small Business Administration, a bank loan, or angel investors.
- Create a Written Agreement--If you DO decide to make a personal loan to a friend or family member, make sure to create a document with the definite terms of the loan and repayment. A written agreement, or promissory note, can detail the terms of the exchange, including the amount, and a repayment schedule that you both sign. This will add a degree of seriousness to the transaction and avoid confusion later down the road.
- Don't Take Money From Your Savings or Retirement--This is a very important tip. If you do not have the money in your regular checking account or disposable cash on hand, then consider yourself unable to make a loan to anyone. Never dip into your savings or retirement to make a loan. If making a loan will affect you adversely, you don't have the money to lend.
- Charge Interest on the Loan--Charging interest helps communicate how seriously you’re taking the loan. In addition to being a persuasive way to get paid back in a timely fashion, charging interest is required by the Internal Revenue Service (IRS) to avoid unfavorable gift tax circumstances. The interest should be based on the current applicable federal rate—usually low—and then reported as income on your tax return.
By taking advantage of the above five tips, you can hopefully make a loan to a friend or family member without damaging your relationship, which is far more important than money.