When you’re in a tough spot financially, you may consider asking friends and family members for assistance. Nine times out of ten, they’re first inclination is to help you out. But many people have learned the hard way that relationships and money are a poor mix. Whether you’re considering asking or making a loan to a friend or loved one, there are a few things you can do to save yourself a lot of stress and strained relationships.
If you’ve been approached to lend money, there are a few things you should consider. First, adopt the casino mindset; only lend money you can afford to lose. Let’s be honest, people don’t intend to renege on their obligation to you, but they’re borrowing money for a reason. Perhaps they’re poor financial managers, or they’re simply unaware of the magnitude of what the impact of their request might be on your finances. Although it wouldn’t be their intent, you may never see your money again. Could you live with that loss? If you are able to lend a hand but are concerned about repayment, you may want to make some stipulations. One approach would be to encourage the borrower to talk to a financial counselor, or participate in a money management class. Upon completion, you can lend them money they requested. If the person is somewhat frivolous, you could agree to only pay certain bills for them, such as groceries or utilities. You could request that they show you a monthly budget to see where the money has gone, giving you the information you need to decide if you want to continue with this loan arrangement or not.
We would also recommend that you draw up a contract. This will help ensure that the relationship remains professional and allow you to establish some reasonable expectations. The contract would indicate how much was borrowed, the repayment term, and whether any interest will be charged. I mention interest because if the loan is in excess of $10,000, a lender is required to charge interest, even if they don’t want to. If there is no interest, then something called the Original Issue Discount would effectively reduce the amount of the loan and require the lender to pick up a portion of the repayment as interest income. Bottom line, check with a tax attorney for larger amount loans. This brings us to a rather uncomfortable clause you may wish to consider – what happens if the loan isn’t repaid. You may want to include language that describes the consequences for failing to meet obligations, such as taking the borrower to court, or sending the account to a collection agency. Sure, it sounds harsh, but it also shows that you’re a good steward of your own money.
I hope those of you who are looking for a loan have been paying attention. Borrowing is serious business, and you have to respect your lender, especially when that lender is a friend or loved one. Here are some tips to help you along the way. First, know precisely how much need. You should have a clear plan of what you require, and why the loan is important. Your plan should also include how the funds will be repaid. Here we suggest that you under-promise and over-deliver. For instance, if you can easily make $100 payments each month, offer $75. Make the $100 payment when you can, and default to your agreed-upon amount if you encounter unexpected problems.
Also, be careful about the people you approach for a loan. To some, family comes before all else, and they may bend over backward to help – even if it puts them in a bad position. Obviously, when you’re looking for help, it should never be at the expense of others. Try to get a sense of your perspective lender’s financial position before approaching them for money. Furthermore, try and borrow from someone who may be sympathetic to your situation. For example, you may have a successful family member who could easily solve your financial troubles, but they may be unbearable to deal with throughout the repayment term. Your situation is stressful enough, and there is no need to overburden yourself with someone who will constantly offer reminders about how they’ve helped you.
Finally, it goes without saying that if you’re struggling to repay the loan, your relationship could suffer unless you follow a few key steps. First, specify the penalties or other consequences for default in your contract, as I mentioned earlier. Second, just as you should do when you borrow from a regular bank, as soon as you realize that you’re going to miss a payment, communicate immediately about the difficulty you’re having. If you don’t, you’ll jeopardize the relationship. And while you may be right in thinking blood is thicker than water, the respect they have for you could be lost in the process. That’s a price you shouldn’t be willing to pay, so be careful. Until next time, I’m Thomas Fox for Cambridge Credit Counseling.