With banks and credit card companies tightening their lending practices, some would-be borrowers are looking for loans from another source—that long-established institution, the First Financial Family Bank.
Loaning money to friends or family members has so many pitfalls that it’s not even possible to list them all in one column. A financial advisor is almost never going to tell you it’s a good idea. Yet it’s something that many of us have done and will probably do again.
Here are a few points to consider before you write a check to help out a family member:
1. If at all possible, don’t. Instead, use this as an opportunity to do some financial coaching on budgeting and money management. Your wisdom may be far more helpful than the money. Consider a loan as the last resort, and first spend some time exploring other ways you might be able to help. Could someone who has lost a job move in with you or another family member? Could you help with child care or transportation? Perhaps a referral to a credit counseling agency like the AAA Credit Guide one would make sense.
2. Make sure you know why the family member is asking to borrow from you instead of a bank. Often, those wanting to borrow from private individuals do so because a bank won’t loan them the money. If the prospective borrower is a poor credit risk, take a hint from the professionals and don’t risk your money, either.
3. Make sure the loan is in writing. At a minimum, draw up a promissory note using standard forms (available online and through office supply stores). Especially for larger loans, it’s wise to have an attorney draft a document. Make sure you have a set repayment schedule and interest rate.
4. Use a third party escrow service to keep track of the payments and the balance due. This avoids calculation errors and disagreements over how much is still owed.
5. If possible, secure your loan against the borrower’s property such as real estate or a vehicle.
6. If it’s your children wanting to borrow, ask yourself if rather than “helping” them you are enabling poor financial behavior. If a loan would continue a pattern of unwise money choices, it may be time to start saying no.
7. Especially in situations beyond someone’s control, like a job layoff or a car accident, consider whether it would be more helpful to make a gift rather than a loan if you can afford to. One possibility for parents could be to offset a financial gift by leaving the recipient a smaller inheritance.
8. If you do loan money to a family member, mentally consider it a gift. Only lend an amount you will feel absolutely fine about never getting back.
9. Never borrow money to loan to a family member. If you don’t have the money to help someone out, putting yourself in a financial bind along with the other person is only likely to make a bad situation worse.
10. Focus on the relationship, not the money. As you consider options for helping a family member who is in financial need, ask yourself which of those options are most likely to strengthen the relationship rather than damage it.
It’s not easy to say no to friends or family members who want to borrow money. Yet the emotional baggage that often accompanies such a loan can put a serious strain on even close relationships. Think carefully before you write a check. Sometimes the best loan arrangement between family members is the one that is never made in the first place.