People who need to borrow money would almost always rather source their funds from a friend or family member. It’s easy to see why. Payday loan companies charge exorbitant rates, and it’s a lot easier to deal with someone you know and care about than with a traditional bank. However, these kinds of situations can be fraught with risk for those lending the money. They’ve caused countless family squabbles and ended untold numbers of friendships. Usually, it’s a result of the borrower not paying back the money on time (if at all).
You can avoid these troubles by being cautious and sensible about who you lend money to. If a friend or family member has asked to borrow money, then imposing clear terms and conditions on the loan is something you must do. With that in mind, here are some questions to ask yourself and strategies to follow to make sure you don’t end up kissing your money (and perhaps your friendship) goodbye.
Assess the Borrower’s Situation
Your essential first step in evaluating a loan request from someone close is to consider whether or not they’re financially responsible. People who are generally good with money sometimes run low on luck and need a helping hand. However, others display patterns of poor financial management. You’ll notice them splurging on items they don’t need, ignoring responsibilities like rent or bills in favor of personal spending, and routinely racking up large credit card balances. If your potential borrower falls into the former category, consider helping them if you can. Otherwise, saying no is likely the wiser move.
Don’t Put Yourself in a Financial Jam to Help Someone Else
The next thing you should do is look at your own financial situation. How are you doing for savings? Do you have a financial cushion? Is your income stable? Do you have any major purchases or expenses coming up?
It’s perfectly all right to look after yourself first. If granting someone else a loan will make it difficult for you to honor your own financial obligations, you wouldn’t be remiss to deny the request. Be honest, and tell the person asking to borrow your money that you simply don’t have any extra to lend. Then suggest your friend or family member looks elsewhere for help.
What if the Money Never Gets Repaid?
If you do decide to lend your friend or family member the money they need, consider what it would do to your personal finances if they never paid you back. Would that jeopardize your own financial stability or leave you struggling to keep up with your own obligations?
When someone close to you asks to borrow money, a good rule of thumb is to think of it as a gift instead of a loan. Doing so will help you make an accurate assessment of how the loan/gift will impact your finances. It will also help you avoid bad feelings or fallout if the borrower defaults on their pledge to repay you. If you think of it as a gift, you weren’t “expecting” to get the money back anyway. Repayment is simply a bonus.
Here’s an insider tip, though. Don’t tell the borrower that you’re thinking of the situation this way. Keep that to yourself, as it will boost your chances of securing a full repayment.
Strategies for Making Sure the Money Gets Repaid
One effective way to boost your chances of getting your money back is to show the borrower you’re treating the situation seriously. If the loan is for a considerable amount of money, create a contract. You retain the sole right to decide what amount qualifies as “considerable,” but the point of drawing up a contract is to give you something to enforce should the situation deteriorate into a legal squabble. For example, a contract would be pretty solid evidence in small claims court.
Make sure your contract clearly states the following.
- The parties involved.
- The amount of the loan, and any interest rates being charged (if applicable).
- The date on which the loan was granted.
- The repayment terms.
It’s also a good idea to obtain objective proof that the borrower received the money from you. Thus, it’s wise to transfer the money from your account to theirs through your bank or an online service like PayPal. That way, a reputable third party can confirm that the loan actually happened if the borrower should be brazen enough to deny it after the fact.
Speaking of repayment terms, follow this advice. You need specify these terms before you grant the loan, not after the money’s already left your hands. Being clear and up front will help avoid misunderstandings. This can prevent a delicate situation from descending into a back-and-forth battle.
Personal finance professionals stress the importance of treating the loan like a business decision. That can be really hard when there’s an emotional pull that comes with seeing a friend or family member struggling. However, keeping things formal shows the borrower you’re approaching their request seriously. It also makes it more likely that they will treat it the same way.
Red Flags and Situations to Avoid
There are no hard and fast rules when it comes to lending money to family and friends. Every situation is different. The most important thing is to make the most objective possible evaluation of the subjective factors at work.
That said, there are some circumstances that should give you pause beyond those already mentioned. Here are a few examples.
Secrecy: If the person approaching you for the loan wants you to keep it hush-hush for reasons that seem questionable or difficult to understand, you’d be well within your rights to pass. This is particularly true if the would-be borrower has a known history of problematic behavior, like compulsive gambling or substance abuse.
Guilt-tripping: Watch out for borrowers who work suspiciously hard to appeal to your compassion or try to make you feel guilty if you hesitate. This can signal ill intent. The only person you have to answer to is yourself if you decide not to grant the loan.
Spotty credit history: Does the borrower have a known history of failing to repay money they’ve borrowed from friends or family members in the past? If so, there’s probably no reason things will be any different this time, no matter what the borrower might say to the contrary.
Dishonesty: If you don’t completely trust the person asking for the money, or if they have a reputation for being dishonest, say no.
Large loan amounts: Never agree to lend someone a sum you’re not fully comfortable with, even if you can absorb the loss if the money isn’t repaid.
At the end of the day, you’re likely to be repaid if you proceed with caution and protect yourself. Good luck and happy lending!