While this may sound a bit harsh, the best rule of thumb when considering lending money to family or friends is simply this; Don’t. That, however, is much more easily said than done, especially when the person that’s asking for the money is your adult son or daughter, your brother or sister or your best friend from childhood. While it’s easy for us to sit back and say “that’s not a good idea”, the reality is that, unless a person is a real Scrooge, they want to help the people in their lives that they are closest to.
With that in mind, if someone you love comes to you during the holidays looking for a loan, use the rules below (and stick to them) to reduce any possible future problems and heartache that your loan might bring. Enjoy.
Rule #1) Make sure that you can afford to lend the money they are asking for. Simply put, you need to think very carefully about what this loan will do to your financial status. If it’s going to really strain your budget or put a lot more stress on your shoulders, you might just have to say no. Likewise, if it’s impossible view to give the loan without tapping into your retirement savings or your emergency fund, it might be a good idea to decline. Of course, if you have the financial means and it won’t put you in any financial risk, considering that loan will be a lot easier.
Rule #2) Take into consideration what could happen if the person you lend to defaults on the loan. Interestingly, a Consumer Credit.com survey found that nearly 33% of potential lenders would still lend money to a friend or family member even if they were aware that they would never see that money again. That being said, even though you might wish to believe that your brother would never leave you hanging, you need to fully consider what would happen if he was unable to repay the money that you are considering giving to him. If you can lend it without fear that you’ll go “broke” or worse, then by all means go right ahead. On the other hand, if non-repayment of your loan would leave you “up the creek without a paddle” then declining is probably your best bet. If you’ve already loaned money and the person is behind on payments, immediately address the problem and do your best to renegotiate any loan terms to make that debt more manageable.
Rule #3) Make sure that everything is in writing, signed and notarized. One of the biggest problems that causes family strife is when one person gives a loan and the other person, when it’s time to pay, disputes what the terms or conditions of the loan were to begin with. For that reason, writing down the terms of the loan and having both parties sign it is a must. This should include the terms, interest rate, payment schedule and length of the loan as well as any other specifications that you may want. Not only is this document legally binding but it also will give both parties a record of the original terms so that, if a dispute arises, it can quickly be put to rest. Recording each payment made on the loan is also an excellent idea.
The rules above are more for personal loans that you give to family members but, if you are considering cosigning a loan for someone, you can use them as well. One caveat is that, when cosigning a loan, be aware that if the person you are cosigning for defaults on the loan you will be 100% responsible for paying it back and, if you are unable to for any reason, your credit will take the hit, not theirs.