I try to keep the issue of money out of my personal relationships. Many people I know outside of those I know only online — my friends and family — read Consumerism Commentary. For the most part, they’re not interested because, I assume, they’d rather keep the issue of money out of our friendships — or they’re just not interested in the topics. Money is not exactly a comfortable topic, particularly when the discussion treads on the more personal aspects, like income, bank account balances, and spending.
Discussing money is usually not a problem once people are open to it. There is more danger when it comes to entering in financial relationships with the people with whom you have personal relationships. For those of us who have an innate desire to help others, it can be difficult turning down a request for a loan, for example. Many years ago, I found an apartment and roommate on Craigslist in order to live close to my job at the time. It was a tiny railroad apartment, but it was a good deal. I was only recently beginning the reconstruction (or initial construction, more accurately) of my finances, and it was the best offer I could find. Only a few months into the arrangement, my roommate needed to borrow money for the rent. I don’t think she had family in the country, so I know she was having a difficult time. I lent her the money.
Although she repaid the loan in full only a few months later, it was after I had moved out of the apartment, and I believe she borrowed the money from someone else to pay me back.
Other people have had worse stories to share. Friends and relatives disappear when they can’t repay the loan. There is a dispute and neither party communicates with the other again.
If you’re lucky to be in a secure enough financial position to loan money to a friend or relative, would you do it? Here are some thoughts to consider.
1. Has he researched other options? Getting a personal loan from a bank or credit union could be difficult, but it’s a starting point. For those who have no luck inside the mainstream financial industry, there are outsider options, though peer-to-peer lending is hardly an outside business at this point. Prosper and Lending Club come to mind, but I know from personal experience that not everyone who needs assistance will qualify for a loan from these places. Nevertheless, research should move from banks and credit unions to peer-to-peer lending before he approaches friends and relatives.
2. Is there any other way you can help? Money may be the root cause of his need to find a loan, but there may be other ways to help him solve this issue without resorting to a financial transaction. If he’s out of work and looking for a job, maybe you can help introduce him to relevant contacts or perhaps arrange an interview. While you don’t usually want to tell your friend how to spend his money, you might want to subtly guide him on a helpful path.
3. If you lend money, will he repay? My suggestion is not to lend any money you can’t afford to lose. A loan is often just a Band-Aid, a temporary fix that won’t fix the larger issue. You may not want to extend a loan if it looks like there is little hope of him paying back. If that is the case and you still want to help, consider offering cash as a gift without the need to repay. If that idea makes you feel uneasy, you probably shouldn’t lend the money, either; without prospects, it’s unlikely he’ll repay you for a long time. If it’s clear his financial is only temporary and you believe he will be cash flow positive soon, you might feel more comfortable providing the loan.
4. If the transaction goes sour, will your relationship follow? Even the strongest relationships dissipate over money. It’s probably easier to replace money in your bank account than it is to replace a life-long friend or a supportive relative. Carefully consider whether the risk is worth the little interest you may receive from the loan.
5. Will you be offended if you don’t believe he’s using your money properly? If you lend money, resist the urge to dictate how the money should be used. I understand that a lender may want to see the money be put to good use. This money should be helping the person become financially independent, either once again or for the first time. You don’t want to see him driving by in a new car or touting the latest iPad 2 the day after you provide the money. Once you sign that check, hand over the cash, or send money through PayPal, it’s no longer yours. You’re entitled to repayments over time plus interest, but you can’t dictate how the money should be used. If you don’t feel confident that he will use the money wisely, don’t provide it.
6. Set a fair interest rate. The purpose of lending money to your friend or relative is not to earn interest on the misfortune or bad choices of others. Resist the urge to punish your friend, the borrower. It’s a good rule of thumb to charge interest at or lower than the rate you could earn in a high-yield savings account. If your money were not to be lent, it’s likely it would be sitting in a savings account anyway. The only reason to lend money to a friend is to help in a time in need, not for profit. If you feel you must charge interest, be fair. It may not be legal to set high rates for personal loans, so make sure you’re aware of the laws in your state.
7. Can you afford to lose the money? In the worst case scenario, you never hear from the borrower again. The relationship is destroyed and you never receive your money back. Aside from the risk to your emotional well-being, can you afford to lose the money? Assume you were providing this loan as a gift, with no expectation of having it paid back. Would you still provide the same amount? Only part with the amount of money you’re willing to never see again. If he does repay the loan, it will feel like a bonus.
8. Make it legal. If you still believe lending money to your friend or relative is worth the risk, draw up a contract to formalize the arrangement. For $14.99, you can buy a promissory note from Nolo, which will allow you to fill in the pertinent information and have a legal contract ready to be signed by you and the borrower. Using a contract helps to signal to the borrower that you’re serious about the arrangement and expect to be paid back, and that perhaps you’re willing to take legal action if you’re not paid. In the back of your mind, though, you might still be under the assumption that this is money you could lose. If the thought of taking legal action against a friend makes you wary of lending money, consider offering a gift or not helping financially.
Would you lend money to a friend or relative? If you have, what have your experiences been?
Updated February 26, 2013 and originally published March 15, 2011. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @flexo on Twitter and visit our Facebook page for more updates.