The smart way to lend money to family and friends
FFinancial experts will tell you to avoid borrowing money from family and friends. And for good reason. Even the healthiest, strongest relationships can give way to the financial problems it can cause. At the same time, in times of financial hardship, there might not be a better place to turn to your loved ones.
For starters, if you’re in a serious rush, this is the fastest, easiest way to get a loan. It can be as simple as depositing a check into your account. Second, it’s a much more affordable option – interest rates can range from 35.99% to a staggering 199% for a personal loan.
But what happens when the shoe is on the other foot? In other words, a family member or friend asks you to borrow money from you. Well, here are 8 smart ways to lend them the money they need while keeping the relationship alive.
1. Sleep on it.
Before making an important decision, many of us are advised to âsleep on itâ. But why?
âConventional wisdom suggests that by ‘sleeping on it’ we clear our minds and relieve ourselves of the immediacy (and the stress that comes with it) of making a decision,â writes John M. Grohol in Live Science. âSleep also helps organize our memories, process the information of the day, and solve problems. Such wisdom also suggests that conscious deliberation helps with decision-making in general.
Plus, research has shown that sometimes we make worse decisions the more we consciously consider them. In order to make better decisions, researchers have found that unconscious thinking – equivalent to sleeping on it – can be helpful.
How does this apply to money lending? Well, you may feel compelled to say “yes” when someone applies for a loan. What, between having the impression of having been embarrassed or having a real concern to help them. However, you should tell them that you need some time to think things over and calculate the numbers.
2. Only lend money to people you trust.
There are many valid reasons for not lending money to your family and friends. For example, reimbursement may not be a priority for them. Ultimately, this could damage the relationship. In fact, nearly a third of borrowers and lenders reported negative consequences, such as resentment or hurt feelings, in a Lending Tree survey.
The quick fix? Only lend money to those who are responsible. And above all, those you trust.
For example, you have a friend who has a bad history of non-paying people. Worse yet, they have an angry temper that makes them bounce from job to job. In this scenario, why would they think they would pay you back on a $ 500 loan?
Also, and this is extremely painful, if the borrower is struggling with an addiction, you have to decline the request. Although it may sound harsh, lending them money helps them. My parents learned this the hard way with my sister when she struggled with an addiction to Oxycontin.
3. Ask what it is for.
Another way to make the decision to lend money to friends or family? Ask them up front why they need the money. In fact, as a lender, you have every right to know where the money is going.
At the same time, if someone asks to borrow a tiny amount, like $ 20 or $ 50, it probably shouldn’t hurt you financially. For this reason, you probably don’t need to grill them. But, for a larger amount, certainly inquire.
For example, if you know they’re going through a financial crisis and can’t pay their bills, and they ask to borrow $ 1,000 for a vacation, that makes the answer easier. It is a categorical no. But if they need that money to replace a furnace as winter approaches, that’s another story.
4. Don’t lend more than you can afford.
When you practice “metta” meditation in Buddhism, you start with yourself. As Troy Erstling explains in an article on Medium, âYou say ‘May I Be happy. May I be free from anger, hatred, animosity, resentment and ill will. May I experience real peace, real happiness, real love. ‘
âAfter you’ve done that, THEN you can move on to saying the same for friends, family and possibly strangers and all living creatures,â Erstling adds.
Starting with yourself may seem selfish, but it is a precious principle in life. And, this certainly applies to lending money to others.
Let’s say you recently lost a source of income or are in the process of paying for an emergency medical procedure. In these situations, you are probably not in the best financial position to help others. As such, you don’t want to put additional financial strain on yourself.
As a general rule, the following should be a priority; âIf you can’t afford to lose it, don’t lend it.
5. Execute a loan agreement.
A written record can help avoid misunderstandings when granting loans to friends or family. If you decide to sue the borrower for your money, it will also be easier for you to do so. After all, you have agreed to a loan agreement and it can be legally binding.
A loan contract must at least include:
- Your name and that of the borrower
- The date the loan was issued
- The amount borrowed
- Repayment terms, such as minimum payment amount and due date
- Interest rate, if you charge it
- Recourse in the event of non-payment. These may include adding additional costs to the loan, taking possession of the collateral, or pursuing legal action.
With a large loan, you may want a lawyer to draft the contract on your behalf. And, if you plan to charge interest on the loan, consult a tax professional.
The interest rate charged must be based on the Federal Applicable Rates (AFR). FYI, loans over $ 10,000 are subject to interest tax. And whether or not you charge interest, if the money is not returned, you may still need to declare it as a gift.
6. Understand taxes and tax consequences.
Are there any legal hurdles to overcome when lending money to friends and family? Not exactly. In other words, it is perfectly legal to lend money to someone else. Still, there are some shortcomings to be aware of, especially if you’re a senior lending money to your adult child.
Patrick Simasko, senior lawyer and heritage preservation specialist at Simasko Law in Mount Clemens, Michigan, told US News that “if you lend your child money and have to go to a house nursing home and apply for Medicaid within the next five years, your child must return the money to you. If they are unable and can never return the money, serious Medicaid divestment penalties will apply. Medicaid will treat it like a gift.
According to Neel Shah, certified financial planner and owner of Beacon Wealth Solutions in Monroe, New Jersey, and estate planning attorney at Shah & Associates, you should also be thinking about the Internal Revenue Service.
“Typically, the IRS believes that no one gets something for nothing. When money or anything of value is transferred to a friend or family member, it will either be a gift, loan, or sale. Each of these elements would have associated tax consequences, âexplains Shah.
7. Make it part of your budget.
Remember to budget for these types of loans if it is something that you do frequently. And this also applies when giving hard cash as a gift.
While it may seem unnecessary, there is a good reason to budget for loans. The gift or loan you give can be planned along with your other financial obligations and goals. In addition, it protects you from your overly thin sprawl, which could put your own financial well-being at risk.
8. Consider alternatives.
Make no mistake about it. Lending money to family or friends can be a bit uncomfortable, to say the least.
Since you care about this person, you want to help them in any way you can. But, on the other hand, it can strain the relationship.
According to a 2019 Bankrate survey, 60% of people have loaned money to a loved one to help them. Unfortunately, it is also more likely to produce a negative result (46%). Of those who have loaned money to friends and family, 37% say they have lost money and 21% say their relationship has been ruined.
Other than not lending them money, what other options do you have? Well, there are actually quite a few alternatives that you can choose from.
First, you can still lend them money, but not as much as they requested. For example, if your brother asked you to borrow $ 1,000 and you are not comfortable with it. Give him $ 500 instead if that’s the most amount you’re willing not to get back.
An other idea? Help them improve their financial literacy. Examples would be explaining to them how to budget, what tools to use and what financial educational resources are available to them.
Finally, you could take risks and co-sign a loan with a financial institution. Or, to reduce this risk, you can suggest that they turn to peer-to-peer lending sites like Lending Club and Prosper.
By John Rampton for Due.com.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.