For most people, having to lend money to anyone is an encroachment of their comfort zone, let alone someone they have a close relationship with. Yet, if done right, lending money to family can be very rewarding. If done wrong, you could end up losing your money and damaging a very important relationship. It's a very fine balance that needs to be maintained.
When to Lend Money to Family and Friends
Before you start writing any checks to your relatives, consider a few factors in making your decision. Not every family dynamic is the same, so it's easier for some people to broach this otherwise taboo topic than others.
Just like a bank would determine the creditworthiness of a borrower for a personal loan, it's a good idea for you to establish a few qualifications, too.
- Accountability: If the person asking for money usually is reliable and dependable, you're obviously going to feel more comfortable with giving them a loan. One advantage here is that if your relationship with this person is close enough to where they can ask you for money, then you'll probably already have a good idea whether or not you can trust them to pay you back. Speaking of which…
- Familiarity: How well do you know this person? There's a difference between family and relative just as there's a difference between friend and acquaintance. It's usually not hard to distinguish the two if you think about it. Certainly, there are some people that fall into a gray area, but generally, you should know who the important people in your life are. Sometimes, it's absolutely fine to just say, "No."
- Accessibility: How often do you communicate with this person? If it's someone you see on a regular basis, getting in contact with them regarding payment status and other issues about the loan shouldn't be a problem. On the other hand, if it's someone who you haven't talked to in a while that just popped up out of the blue, or worse yet, someone you barely know or just met, there are some immediate red flags there.
- Reason: Find out the purpose of the loan. This will also help you gauge the likelihood of ever seeing your money again. Better still, if the money is going towards a momentous occasion like a home purchase, wedding, college tuition or even consolidating debt, you'll be making a direct and positive impact on the borrower's life. On the flip side, if the money is going to be used for a "guaranteed" investment scheme or hair-brained business venture, or even just frivolous expenses, you'll actually be doing your friend or family member a big favor by withholding your dough.
How to Loan Money to Family and Friends
Now that you've established whether or not this person is trustworthy enough to lend to, it's time to actually establish some hard terms for the loan. Most people would say don't let emotion get in the way of how you handle money with family or friends, but unless you're some robot, that's nearly impossible.
Still, do your best to minimize unnecessary pleasantries and only agree to terms you're comfortable with. After all, you're the one doing the favor. The least the borrower can do is ease your peace of mind.
Here are a few suggestions to establishing some ground rules:
- Determine Expected Payment: Whether you want the balance to be paid back through installments or in a lump sum after a certain period is up to you. Installments might be a good idea because you can monitor whether the loan repayment is on track and it may also be easier for the borrower to manage. A lump sum payment, however, requires less upkeep on both ends. The downside is you won't know whether or not you'll be paid back until the due date. By then, it may be too late, so it's probably best to strike a balance between the two.
- Discuss Charging Interest and Penalties: This is when things might get a little weird. You don't want to profit off your friend or family during their time of need, but you also have to consider the time value of your money. Issuing an interest-free loan is going to cost you, especially if it's a long-term one. If you're comfortable with that, then disregard this step, but it is something important to consider. Penalty fees are another way to make sure the payments come in on time, but don't get too carried away.
- Secure Collateral: If your borrower is not the most reliable person in the world, but you can't refuse to help them out for whatever reason, consider establishing some collateral to back the loan. It may be something small but significant like a television set or something big like a car. It may depend on the size of the loan.
- Get It In Writing: You don't want to think about it, but you do need some way to enforce the terms of the personal loan if things go awry. Find out the requirements of a binding contract in your state since most have different rules. Draft up an agreement with the specifics of the loan and have both parties sign it. While you may not be 100 percent comfortable with making things so official, you do need to protect yourself with some sort of legal recourse if you need to collect your money.
While a lot of these tips seem very formal, your approach doesn't have to be. It's important to help out someone you care about, but you also have to protect yourself. You can be serious without being abrasive and cold.
If your friend or family member was comfortable enough to ask you for money, you should be equally comfortable in asking them to agree to reasonable terms. Remember, it's not awkward unless you let it be awkward.
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