Lending money to family and even friends can often lead to problems. This mixture of close personal relationships and activities typically performed by banks is a volatile combination. Banks are usually very strict and heartless because they live by the numbers. Family is supposed to be the opposite - caring, considerate and helpful. These two opposite points of view will often meet each other in a nasty conflict when borrowing money is involved.
I've successfully borrowed and even lent money to friends and family members over the years. All repayments done on time, as expected, and no hard feelings on either side. However, I've also had my fair share of problems from times that didn't work out great at all.
I learned a lot of lessons in both of these types of situations that can really help you if you are considering lending money to family or friends. For anyone that is trying to get someone close to them to lend them money, I also have tips for you that will either help or greatly increase your understanding of the situation if nobody wants to give you a loan.
Lending money to friends and family members can be a touchy subject. Many relationships have been killed over arguments about borrowing money, so you need to be really careful if you decide to lend your hard-earned cash.
In general, I highly recommend exploring other options. Loaning money should be the absolute last option that you use when nothing else is possible. If you are going to go through with it, think about all of the possible outcomes and how everyone would react to each situation. Disappointment usually happens when expectations are not met, so make sure both sides clearly explain their expectations to each other to avoid future problems.
Think carefully about the reason why your friend or family member needs to borrow money. Do they want the cash for a frivolous expense, such as a fancy new dream car, or do they want down payment money to buy a house to improve their life? There's a clear difference between borrowing money to buy a big screen TV and desperately needing a loan to get a cavity filled.
Loan or Gift Money
Banks have rules when it comes to loans that they give out. If you can't qualify, you don't get the loan. When you break the terms of the loan, you suffer the consequences of those actions. This type of behavior doesn't work out very well when you have to treat your mom, dad, sister, brother, kids or best friend in that manner.
When you have a close relationship with someone, you have certain expectations of them. If you're in dire trouble, you would hope that they'll help you out without trying to gain something in return. After all, when you feel like you jump through hoops to help your friends or family, you kind of expect the same in return when you have problems.
With that said, here's my #1 piece of advice when it comes to giving a loan to friends and family. If you have the money and can afford to give it away and never receive a penny back, gift the money instead of loaning it. When you can't afford to lose all of the requested money, then you probably shouldn't be loaning it in the first place. That is how problems are created in this scenario. You lend the money out but need it back before a specific date or else it will cause problems for you. When the date approaches and you haven't been paid, a fight will happen.
It's better to tell someone "No" and deny their loan request instead of giving them a loan that could potentially cripple your own finances. That is why I highly recommend avoiding loans to friends and family entirely. Either you can afford to gift them the money or you can't. If you can't afford it, tell them no and explain why to avoid hurt feelings.
Whenever possible, encourage others to seek out alternative lending sources. Personal loans from a bank are sometimes possible in these situations, and will often work out much better in the long run. This allows the banks to be banks and family to be family without mixing the two.
Unfortunately, if someone is asking you for a loan, there's probably a good chance that alternative funding simply isn't possible for them. Bad credit scores are just one situation that can cause this to happen. However, there may be a good reason why they have poor credit. If they don't pay back others that have lent them cash in the past, they may not pay you back either.
When loans from other sources are possible, you also don't want to end up as a co-signer. This can basically be the same thing as lending the money yourself. Nothing bad would happen if they repay according to their obligations, but if they default on the loan, you will end up responsible. If you end up responsible for their loan, you will end up feeling the same way as though you lent the money yourself and got stiffed.
Clear Loan Terms
If you have decided to go through with a loan to a family member or a close friend, make sure you clearly detail the terms of the loans along with any expectations. Discuss this with the person that will the borrowing from you. Both of you need to be on the same page to avoid misunderstandings down the road.
Depending on how you reacted to the request to lend money, it's possible that hesitant reactions can lead to poor loan terms. Let's say your son has a bad tooth and badly needs $2,000 for a dentist appointment. If he thinks you're on the fence about doing it, he may feel like he needs to pay you back as quickly as possible. This can result in proposing a repayment schedule that is too aggressive to keep up with in reality. The son makes the deal because he has no choice and needs his tooth fixed.
With that said, don't just clearly lay out the terms. Look beyond your own desires and expectations about lending the money. Consider what the borrower can actually afford to pay. If their financial situation was great, they probably wouldn't have the need to borrow from you. If you force a payment schedule that is more than they can handle, you pretty much guarantee that the deal will go sour at some point in the future. Try to factor in the needs of both people when drafting the loan terms.
Remember how I talked about banks and family / friends being polar opposites with how their relationships work? Banks are strict and only focus on making a profit, while family and friends are supposed to have genuine care for one another. You need to make sure that this detail is ironed out in your loan terms ahead of time.
Are you going to be as tough as a bank would be with lending money, or will you show leniency since you have a close relationship with the person borrowing the funds? If you're helping out your daughter with a really important expense, they may expect that you would show leniency in the future if it was necessary to keep up with the loan repayments. However, if you plan to be strict like a bank with the loan but don't express those feelings, there can easily be incompatible expectations on both sides.
Sometimes these factors won't matter, especially if a loan repayment goes as planned. When things go bad and not according to the original plan, that is when problems happen and these additional precautions will become extremely helpful. You simply have to plan accordingly and don't wait until it's too late to figure out the details about how you will handle special circumstances with a loan to friends or family.