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3 Things to Keep in Mind When Lending Money to Family or Friend

2022-03-11

Your heart is in the right place.

You really want to help your family member or friend, but at the same, you’re a little wary of lending money to someone so close to you.

A host of questions spring to mind:

Can you say no?

Will they pay you back?

How much should you give them?

Should you charge them interest?

How will this affect your relationship?

If you’re asking any or all of these questions, then you’re already in the middle of your due diligence process. Lending money should never be taken lightly, and you’re wise to investigate all of your options.

In this blog, we’ll offer a few tips to consider before you make a decision.

1. Know the Facts

It takes a great deal of humility to ask for money. While financial conversations are inherently raw, it’s important to have a frank conversation.

As a potential lender, you must have total clarity on your decision to help, on how much to provide, and on whether or not lending is ultimately the best course of action.

You also need to determine your expectations for the loan.

In other words, will you draw up a contract? Will there be a due date for repayment? What interest rates will you include?

Or, will you simply loan the money in good faith? This can be more common than you think. It’s especially common to borrow money from family for really big purchases, like a wedding or your first home.

As we’ll discuss below, there are certain tax law requirements that may help inform your decision.

Still, however much you decide to loan, you must accept that you might never get all of it back. Recent studies show that nearly 40% of loans to loved ones have resulted in lost money.

2. Protect Your Relationships

Take the pressure off yourself. You don’t need to automatically say “yes” to every lending request.

After ensuring that you can comfortably provide a loan, you then need to assess whether or not a loan will truly benefit your family member or friend.

If it applies, let history help inform your decision:

  • Have you provided them a loan before?

  • If so, how did they use the money

  • Did they honor the agreement and repay you in full?

On the other hand, if this would be the first time you loaned them money, it’s important that you have clarity on how they’ll use the funds.

While you don’t need to micromanage their finances, you do need to have confidence that the money will be used to help them, not harm them (or plunge them further into debt).

One thing is for sure: the moment you lend someone money, your relationship will change.

Though such titles may not be expressly stated, one becomes the creditor, while the other becomes the debtor.

Before you write a check or hand over cash, make sure you have the kind of relationship that can sustain this new financial dimension.

3. Put Your Financial Health First

If you have confidence in the financial responsibility of your friend or family member, cosigning a personal loan may seem like an appealing option.

However, be very careful if you decide to pursue this route, as there are some potential downsides to consider.

For one thing, cosigning a loan can affect your credit score, as the initial inquiry, payment history, and outstanding loan balance may all be reflected on your credit report.

Of course, any delinquent payments could negatively impact your credit score.

It might also seem like a temporary solution to let your family member borrow your credit card. However, this could jeopardize your financial health, as you’ll be directly responsible for any and all purchases made on the card.

If you’re already in credit card debt, it can be particularly risky to lend your card to anyone — however much you may trust them.

Rather than giving financial carte blanche with your credit, it might be safer to offer a predetermined amount of money — as a loan or a gift.

Moving Forward

Your friends and family are lucky to have you on their side.

However you choose to proceed, remember that you’ll be the greatest support to those around you when your own financial health is strong.

Welcome to First Phase: where less-than-perfect is more than enough.

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