According to a 2013 survey by American Consumer Credit Counseling, 82 percent of Americans polled would let a relative borrow cash if asked (and 66 percent said they'd loan money to a friend). If you find yourself in a position where you need to involve family or friends to alleviate a financial burden, heed the following advice from Bruce McClary, Vice President of Communications for the National Foundation for Credit Counseling (NFCC), and Lynnette Khalfani-Cox, a personal finance expert and author of Zero Debt: The Ultimate Guide to Financial Freedom.
1. IF YOU WANT TO SAY YES, ASK YOURSELF WHY.
According to Khalfani-Cox, too often people are wary of turning down a request to loan money because they’re afraid of straining a personal relationship or being seen as selfish or uncooperative—all poor reasons to say yes. “Nobody’s relationship should depend on a person’s ability to loan money,” she says. “If a ‘no’ would hurt it, it might not be on as strong a foundation as you thought.” She also cautions against loaning money because you enjoy being generous. “Some people may feel like a hero, like they’re coming to the rescue. That’s an emotional choice, not a financially prudent one.”
2. CONSIDER AN ALTERNATIVE.
A cursory refusal could conceivably lead to hurt feelings. If you decline someone’s request for money, elaborate on the steps the borrower could take to resolve the situation themselves. “The best way for people to decline a loan request is to be honest about it and offer a solution,” Khalfani-Cox says. “If someone wanted to borrow $5000 for equipment for a start-up company, you could say, ‘I can’t help you with this, but have you considered renting the equipment?’”
3. PREPARE A WRITTEN AGREEMENT.
While no relatives should be treating each other like a bank, it’s not a bad idea to treat the transaction as though you were sitting in one. A written agreement, or promissory note, can detail the terms of the exchange, including the amount, a repayment schedule, and under what circumstances the lender would forgive the loan. “It can also establish what the consequences are for not repaying,” McClary says. “You can get it notarized, which makes the agreement more enforceable.”
4. CONSULT WITH YOUR SPOUSE.
It’s not typically necessary to huddle with your husband or wife before loaning or borrowing $50, but any sizable amount should probably be discussed with a significant other before committing. If he or she disagrees with the decision, it could lead to some stressful conversations down the road. “I can’t tell you how many times parents have regretted loaning money to their kids because it created stress and friction in their own households,” Khalfani-Cox says.
5. DON’T DIP INTO YOUR RETIREMENT FUND.
Khalfani-Cox has been a consultant for the American Association of Retired Persons (AARP) for five years and has seen lenders dip into their secured funds to satisfy loan requests. It’s a mistake, she says. “It’s fiscally imprudent to dip into retirement savings, sell stock, or forego contributions. If it hurts you, then you don’t really have the money to give.”
6. DON’T GET HUNG UP ON HOW THE MONEY IS SPENT.
Most relatives and friends aren’t going to tell you they need money for a new roof when they secretly want to beat the house in blackjack. But cash earmarked for home improvements might suddenly need to be diverted for reasons that seem important to the borrower. If the loan doesn’t wind up being spent the way you thought, it doesn’t do you much good to dwell on it. “If they deviated, there was probably good reason," Khalfani-Cox says. "It’s not your place to micro-manage every element.”
7. CHARGE INTEREST.
“The reason people approach family is because they feel they have some latitude in taking longer to repay,” McClary says. “Charging interest helps communicate how seriously you’re taking the loan.” In addition to being a persuasive way to get paid back in a timely fashion, charging interest is required by the Internal Revenue Service (IRS) to avoid unfavorable gift tax circumstances. The interest should be based on the current applicable federal rate—usually low—and then reported as income on your tax return. (If it’s not repaid, that can mean it’s considered a gift, which carries a separate laundry list of income responsibilities for both you and the borrower. Check with a local attorney for specific state and federal guidelines.)
8. REALIZE WHY THEY CAME TO YOU IN THE FIRST PLACE.
If your terms aren’t much different from a conventional loan from a financial institution, there’s really only one reason a relative or friend would come to you: No bank considers them a good credit risk. “If someone is asking for money, it shows you there’s already an issue,” Khalfani-Cox says. “You may never get it back, so if you’ll harbor hard feelings about that, think twice.”
9. SPELL OUT HOW AND WHEN THE MONEY SHOULD BE PAID BACK.
Is the borrower expected to pay the lender back in one lump sum or in installments? Is it due within a year or within three? Will they be getting cash, checks in the mail, or in person? The more detail you confirm in the written agreement, the less risk there is for confusion. “Spell out that you expect payments on schedule, that you're lending them this much, and in the end, you’re collecting this much in principal and interest,” McClary says. “Structure the terms as specifically as possible.”
10. DON’T BE AFRAID TO SAY NO.
While most people want to help out someone in a jam, Khalfani-Cox says that it’s a mistake to assume the worst-case scenario will come to pass if you decide not to. “If your brother wants $200 so his cell phone doesn’t get shut off, there are only a few outcomes. He goes to someone for help, he comes up with the money on his own, he makes a deal with the phone company, or his phone gets disconnected. In three of the four outcomes, it got resolved in a good way without you having to step into it. Usually, there’s another option or solution.”
All images courtesy of iStock.