Lending Money to Family and Friends

If you really care about someone and they ask you for something, your first inclination is probably to say “yes” without much thought. But, when someone you care about asks you for a financial loan, it’s usually a good idea to take some time to think it over before answering.

People loan money to family and friends all the time, but doing so can become a bit tricky. In many cases, lending money to someone you care about turns out to be an uncomplicated, completely trouble-free experience. However, sometimes, lending money to a friend or loved one can lead to problems.

Loaning money to anyone is always somewhat of a gamble. It’s impossible to know with absolute certainty that you will ever see the money again. So it’s often best to lend money only when you are prepared to lose it, if it should come to that… and to never, ever make a loan that puts your own financial security in jeopardy.

If you’re thinking about lending money to a close friend or family member, you may find the following suggestions helpful. (This information SHOULD NEVER replace the advice of a financial expert. ALWAYS consult a trusted economic advisor.)

A few things to think about before lending…

  • Use logic. Do not say “yes” because you feel obligated, guilty, or desperate to help. Try to look at the situation realistically and act sensibly without being influenced by emotion.

  • Check into legal/tax issues. The IRS has specific criteria concerning loans and monetary gifts. You may be surprised to find out that a loan with a low interest rate might actually be considered a gift rather than a loan by the IRS, which means a gift tax may be required.

  • Define the transaction. Are you making a financial loan with specific terms or are you providing a monetary gift that may or may not be required to be returned? If it is a loan, make sure everyone understands exactly what that means. Both parties should be in agreement about the details involved, such as the amount of the loan, when payments will be made, how payments will be made, the consequences of missing a payment, etc. Be sure to set reasonable and attainable repayment terms that work well for both parties.

  • Put it in writing. Establish a legal record of the transaction by spelling out all the details of the loan in a written document, which is often referred to as a “promissory note.” Include all the terms and conditions of the loan. The document should be signed by both parties. You may also want to have the document notarized. Free promissory note forms are available online.

  • Keep the lines of communication open. If you provide a loan to someone, it is vital to stay in contact with that person. There will be far fewer opportunities for conflict if you’re able to talk through any issues that may come up as they happen. You may want to check in with each other regularly to touch base and make sure you continue to stay “on the same page.”

  • Treat the loan as a business arrangement. If you have taken the time and put in the effort to prepare your loan as a legal transaction, both parties should be expected to treat it as such. You are the lender and your friend or loved one is the borrower. Maintain your roles and there will be fewer “gray areas” that might result in confusion or uncertainty.

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