Lending Money to Family and Friends

Lending money to family or friends can be very risky. Almost half (50%) of all personal loans given to family or friends end badly. You can lose your money and your relationship with that person. In a recent survey, many people reported that their relationship was damaged as a result of a personal loan, and over 1/3 lost the money they lent.

Many young adults ask parents to cosign a loan (e.g., a new auto lease), but this can also result in problems, including having your credit score damaged and stuck with the payments yourself.

What are the best ways to respond when family or friends ask for a loan?

First, you need to find out why they need the loan and how they intend to use it. Many times, loan requests are not for the amount required at the time, but for more money than is needed. Guess what happens to the extra money? It gets spent on non-essential items and is never seen again.

Ask a lot of questions about the loan request. If you simply do not have money to lend, be upfront, and tell the person. Cut the conversation short and say, "No, I can't do it at this time," there is no need to explain your financial situation to someone asking for a loan. Many times, the person asks, "Why not?" You are not obligated to explain your financial situation.

What are the pros and cons of lending money to friends or family?

So, there are many cons to lending money to family and friends, as noted above. But there can be positives as well. When the request is from a child (or when lending money to the family) who is now out on their own, they may be experiencing tough times and have lower earnings to draw from. Parents want to see their children succeed and are willing to help when they can.

Helping with educational expenses, getting that first car, and similar situations can be really helpful to your child. Maybe even a life changer. Just do not make it a habit. However, loaning money to friends rarely works out. Often the money is never repaid, and the friendship is lost.

When should you say no?

If you are not comfortable lending to any person, then do not do so. If you agree to still lend money, consider it to be a gift that will never be repaid. Never give more money than you can afford to lose. Your attitude should be it will not come back to you. Consider it the same as if you burned the money yourself.

If you say yes, should you set terms or conditions, why?

You must always set expectations and come to an agreement as to how much the loan will be, how it will be paid back, and on what timeline. Then write it down as a 'Loan Agreement' that specifically states what you have agreed to verbally.

Make sure you both sign and date it. It should include the day each month that the agreed-upon payment will be made and the additional cost or penalty if the payment is late. Treat it like any loan you would sign for yourself.

When you go to buy or lease a new car, you complete and sign an agreement with all the information on it, including the consequences of missing payments. Treat a personal loan the same way. By doing so, the other person realizes you are serious and need the money repaid and is more likely to do so.

What are the mistakes to avoid when lending money to family and friends?

The biggest mistake is the obvious one, making a verbal agreement that is not detailed and will likely not be remembered the same by both parties. Then he said/she said kind of scenario that never ends well. Discussing the loan request upfront and in detail and then putting it in writing is always the best way to proceed.

Follow these common-sense guidelines, and you are more likely to have a positive outcome when loaning money to family and friends.