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In this series Empirical advisors answer common questions about financial planning and investing as an individual. If you have a question for our advisors, please leave your name and question in the comment section at the bottom of this article.

Should I loan money to family or friends?

Loaning money to family and friends

There are many reasons why loaning money to family and friends is unsuitable for certain individuals and an uncomfortable subject for those who choose to do it. However, it can be difficult to turn others down or withhold help, especially if close family members are involved. Given the sensitive nature of these situations, money can complicate and sometimes poison meaningful relationships.

Due to the most recent economic downturn, adult children are seeking more financial support from their parents, and often on a long-term basis. The quality of interaction we have with close family and friends is very important, so we want to share a few tips that may help one manage this situation and keep their relationship with a borrowing child, friend or family member from unraveling.

Make sure you have the money to lend

Loaning money is sometimes a gamble. Never issue a loan if it could threaten your own financial safety and goals. This is particularly important if the loan would involve use of your retirement savings.

Ask why the money is needed

This is a delicate question but an important one. Once you know their reason, here are some issues to consider:

  • Are you willing to loan money for luxury or unneeded items?
  • If the loan is for vital reasons, are you fixing or prolonging the issue?
  • Is there a non-financial solution to the problem?
  • How is the loan recipient’s finance management?
  • Are you willing to loan money to individuals who already owe you money?

Put it in writing

While it can be uncomfortable to treat the situation as a business transaction, if the recipient is serious about repaying the loan, they’ll understand the importance of drawing up a contract. This will protect you from any misconceptions or memory lapses later on. Make sure to include the following information in a contract:

  • Dollar amount loaned
  • Interest rate (if any)
  • Late fees (if any)
  • Terms of repayment (lump sum or payments)
  • Loan due date

Turn down the habitual borrowers

If certain people in your lives are notorious for never repaying their loans, instead, offer to pay for financial counseling to help them overcome the routine behaviors that lead them to continually borrow money. Constantly supplying loans without consequences can lead to distrust and could eventually ruin relationships.

Enforce the agreement

There is always a chance that the loan recipient will not pay you back, either intentionally or unintentionally.  If payments are missed, or the loan recipient has trouble abiding by other agreed upon terms, refer to the contract and the stipulations that were established to address the issue at hand, and enforce it. Referencing the agreement will help keep the matter from getting too personal.

Consider making the loan a gift

A gift involves far less stress than a loan – there is no need for a contract, repayment schedule, etc. If you can afford it, and the loan recipient isn’t a habitual borrower, a financial gift can be a real blessing to those in need. Be clear that you do not expect the money to be repaid, thus eliminating pressure on both parties.

If you have a spouse or partner, it is prudent to discuss how you will address financial support to family members in advance of receiving a request.  It may prove productive to agree on limits that would apply to all members of the family.  In essence, establish a lifetime gift limit to family members and abide by it.  This will keep things in balance and unemotional when situations arise.

Helping family and friends, especially around the holidays, is a very natural instinct. If you are not entirely comfortable with issuing a loan, don’t do it. However, if you have the financial capacity, trust and diligence to abide by an agreement, issuing a loan may be a good idea.  Make sure to keep the advice in this article in mind throughout the process.

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About Kenneth R. Smith

Ken is the Chief Executive Officer of Empirical Wealth Management. He holds an M.S. in financial analysis and is a Certified Financial Planner®.

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