When a friend or family member asks for a loan, it can be hard to say no. When the person is part of your support system, you may feel an emotional obligation to help them out. But lending money to loved ones can sometimes have unintended consequences and quickly become complicated.
Is Loaning Money to a Friend or Family Member a Good Idea?
This is a big question, and the answer is: it depends. It depends on a few different factors including who the person is and your current financial situation. To help you navigate the situation, we’ve collected some dos and don’ts about loaning money to friends and family to help guide your decision-making the next time a loved one asks for some extra cash.
5 Questions to Consider When Loaning Money to Friends and Family
1. Is this a family member or a friend?
Whether it’s a family member or a close friend, the main thing to consider is how well you know this person. If you’re really close, you probably have an idea about how responsible they are with money.
Think about what you know about them. Do they pay bills on time? Do you trust them? Would you be okay with the relationship changing if they never pay you back? A recent survey found that about a third of Americans reported negative consequences resulting from loaning money to friends or family, and about 1 in 10 reported decreased contact. On the flip side, if you trust the person, this is a nice gesture of goodwill.
2. Can you afford it?
Have you heard the expression “Don't set yourself on fire trying to keep others warm?” That principle applies here. If loaning out money to your friend or family member will negatively affect your personal finances, it’s better to pass. Your own bank account, emergency fund, bills, and debts should come first.
3. What should the repayment terms be for a loan to a friend or family member?
“Just pay me back whenever” — that’s not a good repayment term for a private loan to friends or family. When you’re the lender, be sure to set clear repayment terms in a loan agreement (also called a Promissory Note). Your repayment terms may vary depending on the loan amount. If you’re lending about $200, maybe the repayment term could be shorter, but if you’re lending out $1,000, you may want to give the borrower a bit more time.
Whatever you decide, it’s important to get the loan terms in writing and have both yourself and the borrower sign the document. This way, you have documentation of your loan agreement if the repayment date passes and you don’t have your money back. While signing an agreement may seem a little too businesslike for a personal arrangement to lend a few bucks — it can actually make it easier to talk through and then follow up on later.
4. Will you get your money back?
While your close friends or family members may be extremely responsible, there’s always that tiny chance that they skip out on the balance. One Bankrate survey found that, after lending cash to a friend or family member, 37% said they lost money. That doesn’t necessarily mean they didn’t see any payback, only that they didn’t recoup the full amount.
Still, it’s worth noting that you should only lend money to family or friends if you’re okay with the possibility of not being repaid. Of course, you hope that won’t happen, but it’s a possibility that any lender should be prepared for. And it might not be all or nothing. You may receive a partial payment back but then need to be consistent with following up to get the rest. One of the benefits of having the agreement in writing is that it’s a black and white document of the expectations that ultimately got you comfortable with the idea of lending money.
5. Do you want to do it?
Remember that “no” is a complete sentence. It can be difficult but there are other ways to turn them down with grace. Ultimately, you don’t have to loan money if you don’t want to.
Lending money to friends or family who have poor financial management skills can make them reliant on you to bail them out whenever there’s a problem. If you sense this might happen, think about other ways to help your friend or loved one. Could you help them create a budget or research other loan options to consider? Those solutions may be more helpful for them in the long term than a small loan in the shorter term.
The Bottom Line on Lending Money to Family and Friends
Loaning money to friends and family is a personal decision. On one hand, it’s a good sign for your own financial security if people are asking you for funds. But, if things go wrong, you could end up with strained relationships. You should also speak with a tax professional in your state before loaning money to understand how much interest you should charge (if any) or if you’ll face any tax implications based on the amount of money you lend out.
If you’re aware of the risks and create a proper, documented plan for yourself and the borrower, you have a much better chance of preserving your own finances and your relationships.
This content provided is for educational and informational purposes only and does not constitute financial or legal advice. RISE is not acting as a credit counseling or repair service, debt consolidation service, or credit services organization in providing this content. RISE makes no representation about the reliability or suitability of the information provided – any action you take based on this content is at your own risk.
