It can happen to any of us: One minute we’re a friend or family member; the next moment, we are a loan officer at a bank. Or at least, it can feel that way if you’re ever in that awkward position of being asked to lend money.
There are plenty of reasons you might be asked for money. Maybe inflation, which has been easing this year, has nonetheless gotten the best of someone. Maybe a family member or friend has lost their job. Or, maybe the person asking for money is simply a complete disaster when it comes to making financial decisions.
But lending money to a friend or relative can be risky. You may not get paid back, or if it takes a long time to get the money back, your relationship may crack under the pressure.
Still, despite the risks, you may be inclined to extend a family member or friend some credit anyway. If you decide to do it, here’s how:
How to Lend Money Safely
If you’re lending money to a close family member or friend, you don’t need to be concerned for your physical safety — but your financial safety is another matter.
There are several steps you’re going to want to take, including:
— Tell your friend or relative you’ll think about lending them money. Impulse shopping is bad enough; impulse lending could be really dangerous. If this is a significant loan, you owe it to yourself to determine if you can afford to lend your hard-earned cash.
— Look at your finances before making a loan. What does your cash flow look like? In other words, check your budget first — preferably look at it for a few months out, in case there are some major expenses lurking ahead that you have forgotten about.
— Get everything in writing. The more money you lend, the more important this becomes. For instance, when will you get your money back? Will the friend or family member pay you the entire sum back all at once or gradually?
— Think about the risks. What happens if your family member or friend simply can’t pay you back? Is helping somebody out something that could become a serious financial setback for you?
— Consider setting the debt repayment plan on autopay. Sure, it might sound extreme, but creditors that you owe often ask you to do it. It also may be a practical way to ensure you do get paid back on time.
— Understand the legal and tax consequences. There may be some consequences, depending on the borrower’s age and how much money you’re lending.
— Consider whether to charge interest. It’s perfectly reasonable to ask for interest, especially if this loan is going to cause you to make financial sacrifices.
— Be comfortable saying no. No explanation needed.
Look at Your Finances Before Making a Loan
If a relative or friend asks you for a loan and you think the answer is going to be “yes,” don’t signal that right away. If you do, you’ll be setting up the person for disappointment if you decide that you can’t after all. And, unless you’re really excited to help this person out and don’t mind being their personal bank, you probably don’t want to let them know it was an easy decision because they might come back to you repeatedly for loans.
So, telling someone that you’ll need to look at your budget first should create some space for you to think about it. And delaying a “yes” should set the template that lending money isn’t something you do a lot.
[Read: How to Make a Budget — and Stick to It.]
Also, don’t be afraid to ask what the money will be used for. Chances are, your family member or friend will volunteer the information but if they don’t you’re well within your rights to ask.
Meanwhile, you need to look at your budget first and see how lending this money will affect you — especially if the friend or relative plans to take their time paying you back. If you can’t afford to lose this money, you’re taking a chance lending it out. If you don’t feel as if your own finances are sound, that’s even more reason to decline.
Any friend or family member who truly cares about you is going to understand if you simply can’t afford to do it.
Get Everything in Writing
You and your borrower need to decide on a plan for repayment — and it should be in writing.
That’s a suggestion from Timothy Wiedman, a retired management and human resources professor who lives in Grand Rapids, Michigan. He says that he once lent money to his girlfriend, now wife, and they put everything in writing.
He suggests putting everything in your written agreement, including “the date of the loan, loan amount, repayment terms, interest rate, payment due dates and so forth.”
Diana Howard, a financial analyst at the coupon website CouponBirds, also recommends getting everything down in writing.
“Decide together what date your friend or family member should have repaid you by, or should have started to repay you in installments,” she says.
“These terms can always change if needed, and in reality, getting it down in writing does almost as much to protect the borrower as it does the lender. It means neither of you can unexpectedly change the terms and will help stave off disagreements,” she adds.
Howard also suggests possibly bringing in some technology into the picture, like budgeting apps. “There are some helpful apps that can help you keep track of money owed, such as Splitwise,” she says.
[Read: Best Budget Apps.]
Think About the Risks
“Be prepared that you may never get the money back, and make sure you can deal with that mentally,” says Wayne Maslyk, president and CEO at Great Lakes Benefits and Wealth Management in Sandusky, Ohio.
If you’re OK with that, then it’s probably okay to lend the money.
And if it’s a loose arrangement and you don’t have everything in writing or a formal payment plan, “be prepared to be flexible, and then be prepared for uncomfortable Thanksgiving dinners and the like, if they don’t pay as agreed,” Maslyk says.
Consider Setting the Debt Repayment Plan on Autopay
Maggie Germano, a financial coach based in Syracuse, New York, has an idea you’ll want to attach to your written agreement.
When Germano’s father-in-law offered to pay off his son’s student loans, they did something very smart.
“They agreed to a payment plan,” Germano says, “and my husband set up auto payments to his father through his bank account.”
He never missed a payment, she says, and he eventually paid off the loan. Meanwhile, they never had arguments or even conversations about the money because the payments were automatic and seamless.
Understand the Legal and Tax Consequences
There are some tricky legal loopholes parents need to be aware of when lending money to an adult child.
“If you loan your child money and have to go into a nursing home and apply for Medicaid within the following five years, your child has to give you the money back. If they’re unable to, there are serious Medicaid divestment penalties that will apply. Medicaid will treat it as a gift,” says Patrick Simasko, an elder law attorney and wealth preservation specialist at Simasko Law in Mount Clemens, Michigan.
Consider Whether to Charge Interest
Charging interest on your loan is certainly your right. Typically, retail lenders will charge anywhere from a friendly 6% to an obscene 36% on personal loans and credit cards. Before inflation kicked in, it was easier to find loans for under 6%. If this is to a family member or friend, you should probably stay on the low side.
[Inflation Calculator: See How Much Inflation Is Costing You]
But don’t spend that interest before you get it — and don’t plan on getting it.
“I never make recommendations as to interest rates,” Simasko says. “If you’re preparing to loan money to a friend or family member, the only thing you should prepare for is never getting that money back.”
Reasons You Might Want to Say “No”
You might have a lot of reasons to say “yes” to lending money to a family member or friend.
But if your gut is saying no, here are some reasons why it may not be a good idea.
— Was this family member or friend turned down for loans already? “Generally, if a bank won’t lend money to someone it’s your first red flag that you are dealing with someone that is likely a credit risk,” says Kimberly Maez, a private wealth advisor with Ameriprise Financial Services based in Castle Rock, Colorado.
— Is the family member or friend evasive about how they’re going to use the money? If you’re lending money, you’re entitled to ask how it’s going to be spent. “Should they not wish to provide details or if they are not open to your feedback, those are both be red flags, and there is an even a lower chance of repayment,” Maez says.
— Do you feel like you’re actually helping your friend or family member or kicking a problem down the road? In other words, will they ask for another loan soon after they pay this one off — or even before? “The worst cases I have seen involve parents that cannot say no to their adult children,” Maez says. “This type of situation can devolve rapidly should the correct expectations not be set at the beginning. Helping someone in a pinch is one thing, enabling poor behavior is quite another. Sometimes the line between those two things is fuzzy.”
Be Comfortable Saying No
You should never feel obligated to part with your hard-earned cash. If you don’t want to loan the money you could say something along the lines of you have a policy that you don’t lend family members or friends money and that it’s nothing personal.
“I’ve seen relationships completely ravaged by money loans. Entire families have been destroyed,” Simasko says. “If you’re in the position where you cannot afford to lose the money, simply explain that to your family member or friend. Communication is key. If they truly understand that you’re not in the position to lend the money, then all should be well-received.”
Germano offers a few tips to keep in mind as you’re crafting a reply.
— Get to the point and be forthright. “Be as kind and compassionate as you can be, but clearly tell them that you are not able to lend or give them money at this time,” she says.
— You can still offer your assistance. “To make sure that they know that you still care, ask if there are any other nonmonetary ways that you could help them,” she says. For instance, you could regularly babysit to spare your friend or family member the cost of child care.
— It isn’t fair to you if you go broke helping somebody else. “When saying no to a request for money, it’s important to center your own goals and needs first. Don’t feel pressured to give money to your loved ones if you’re uncomfortable or incapable of doing it,” she says.
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How to Lend Money to Family and Friends originally appeared on usnews.com
Update 11/16/23: This story was previously published at an earlier date and has been updated with new information.
