- Many people lend money to help family or friends out of a tight spot.
- While such arrangements can be positive, they also may change the relationship you share.
- It’s important to clarify all elements of a prospective loan.
When a family member or friend finds themselves in a tight spot, they may ask you for a loan to tide them over. Many people find it hard to say no in such circumstances because wanting to lend a hand and help those we care about is natural. In fact, research by the Consumer Financial Protection Bureau (CFPB) shows that one in three people provide this type of financial support to others.
If you’re considering lending to family or friends, there are some steps you can take to help ensure it’s a positive experience for both of you. Below are some essentials to think about to avoid unintended pitfalls that might harm your relationship or your finances.
Prioritize Your Relationship and Understand Your Arrangement
Giving financial help to someone you know and trust may seem like a no-brainer at first glance. Lending money to someone in need can strengthen already close bonds. But any arrangement involving money can add a whole new dimension to a valued relationship.
It’s important to establish the details of your arrangement first. That way, you can better judge the best way to preserve and strengthen the relationship. Here’s what we mean.
Clarify the need and purpose of a loan
Before you agree to lend money, make sure you fully understand the reason why money is needed and how funds will be used. Chances are your relative will volunteer this information. But you should ask for specifics about how they plan to spend the money and what led to the shortfall.
As you explore, be careful not to come across as judgmental or intrusive. Your motivation is to understand what help they need and whether you are equipped to provide it.
Discover what’s truly behind the need. People tend to focus on dollar amounts by saying phrases like, “I need $700 to make ends meet this month” or “My paycheck was $300 less this time.” While that may be true, talking out the “whys” can give insight into what caused the tight spot. Is this likely to be a recurring problem? Are there other ways for you to help them?
Establish relationship dynamics
Any money that is lent creates a lender-borrower relationship. And that shift has the potential to change a personal relationship — a little or a lot.
Consider how well you know the person asking you for a loan. If it’s a close family member, for instance, you probably have an idea about how trustworthy they are and how responsibly they handle money. If it’s a distant relative or recent friend, however, you might not be so sure.
Be aware of your relationship dynamics. For instance, an adult child will likely turn to his parents in a pinch. Even if you are close to someone, approaching the request objectively can help the parties involved increase the chances of a good outcome. From there, you can look for solutions together as equals.
Remember, a key goal in a lending situation is to make sure you and your family member maintain the same strong and supportive relationship you’ve had all along — acting in a way that preserves everyone’s dignity and maintains respect.
Key Considerations if Friends or Family Ask You for a Loan
There are multiple issues to keep in mind when making a lending decision, and one of them is considering the impact on your financial situation. So, when a friend or relative asks you for a loan, think about the following:
- “Am I in a position to do this?”
- “Have they borrowed from me before?”
- “Will they realistically be able to pay me back?”
- “Are there other options besides opening my checkbook?”
- “Would I be significantly harmed if they fail to pay me back?”
- “Could I manage the situation – emotionally and financially – if it takes them longer to pay me back than we agreed?”
You’ll also want to give yourself some time to see how comfortable you are with the arrangement.
Decide if you can afford it
It may be hard to turn down requests for help from family and friends, but it’s important to consider your own financial circumstances, too. If you’re thinking about lending cash, think about whether you’re in a position to do so. Is your income stable? Are you covering your own expenses comfortably? Is your rainy-day fund well-stocked? What kind of expenses could crop up over the course of a loan? It’s always a good idea to remember that money you lend out can no longer be considered part of your savings until it is paid back.
Bottom line: In any lending arrangement, you never want to be unpleasantly surprised by the outcome. One solution may be to lend just a little or in installments. You might not be able to part with $1,000 without feeling pinched, but $200 could be a pain-free option.
If you decide you’re unable to make a loan, be clear and honest with your friend or relative about your decision. In fact, a blanket answer is acceptable, and it can be as simple as: “I’m not in a financial position to lend money right now.”
You can also make it clear that saying no doesn’t mean you don’t care. You can follow up a conversation with: “Our relationship is important to me, and I care about your challenge. Let’s explore some options to see if we can come up with another solution for the money problem.”
Consider resourceful alternatives
There may be other ways to support your family member or friend. Brainstorm some alternatives that help fill their cash gap or research sensible loan options.
For instance, maybe you know someone in the same field of work as your friend who might be able to offer a side hustle. Or perhaps you can suggest creative ways to address the problem. For example, say an adult daughter comes to her retired dad with a money need for childcare expenses. The father may not be able to offer a substantial amount of cash, but he can offer his time. In such a scenario, he may be able to watch his grandchildren three days a week, saving his daughter several hundred dollars in childcare expenses. That option solves the money need — plus, it gives grandpa a chance to spend quality time with his grandkids. Win-win!
Tips for Managing a Family Loan Agreement
If you’ve carefully considered a request and decide to say yes, be clear about the terms of a loan upfront. You can consider whether an informal or formal plan fits the circumstances, but you should always document an agreement that outlines expectations in writing. As you do, don’t try to write it as if it came from a bank; instead make it appropriate for the relationship and comfort level you share.
Make a mutual agreement
Drafting a signed IOU, or “promissory note,” indicates that the lending responsibility is being taken seriously – and that it goes beyond a handshake. But if that sounds old-fashioned, do it a different way. All you are trying to do is come to a shared agreement that is explicitly acknowledged. When key essentials like amount, repayment plan and interest (if charged) are spelled out, you can rest assured that everyone involved understands the arrangement.
Openly clarifying repayment terms, for instance, can communicate both structured respect or caring flexibility. It also helps keep emotion out of the arrangement. And to create accountability, charging a small amount of interest may inspire the borrower to repay in a timely way plus offer you a fair way to protect your interests.
This worksheet from the CFPB can help guide your lending plan and provide a starting point for a family loan agreement. Depending on the amount of money you lend and for how long, you’ll want to get professional advice on what, if any, interest rate to charge or if there are any tax implications that apply.
Anticipate the possibility you won’t be repaid
Even with the best planning, there’s always a possibility that you won’t get paid back in full. In spite of your agreed-upon terms, something unexpected could happen that either delays repayment or makes it unlikely.
The benefit of having a written agreement in place is that it eliminates the chance that the borrower considers the money a gift. A good rule of thumb is to never lend more than you can afford to lose.
Lending Financial Support
There’s no guarantee that lending money to family and friends will always work out perfectly. But by clarifying the purpose, examining your finances, considering creative alternatives and setting expectations, you’ll have a better chance of preserving your relationship and making the decision that’s best for you.