5 Questions You Should Ask Yourself before Loaning Money to Friends or Relatives

Conventional wisdom says never loan money to friends or relatives. But when approached by a close friend or relative for a loan, it is difficult to turn them down. Before you decide one way or the other, ask yourself these questions.

Can you afford it?
moneyUltimately, your primary responsibility is towards yourself and your family. Will making this loan impact your financial plans? There is no point in loaning money to others, if it will eventually lead you to having to ask for a loan. You should answer “yes” only if you have money above and beyond meeting your basic expenditure, retirement savings commitments, debt repayment commitments and short term plans. Never use your emergency funds or your retirement savings to loan money to anyone (not even to yourself!).

Can you write it off?
Can you handle the financial risk associated with the loan? What if the person does not repay you or takes a very long time to repay you? Can you afford to write it off? An alternate way to think of this is, would you give the beneficiary the amount in question as a gift? In some cases, such as parents providing their children the funds required to kick start their career, the answer to this question may be a “yes”. In some other cases, such as loaning to a friend who has a weakness for horse races, the answer may be “no”. So look closely at your situation and determine the answer that is correct for you.

What is the loan for?
If you have answered “yes” to both the questions, find out what the loan is for. Let’s say it’s for someone to start a new venture. Ask questions before making the loan to determine if they have a sound business plan. Check if they will have any partners and if the partners are reliable. You need to be careful here and make it clear that you will not loan the money unless you know full well what it is for. This can prevent a lot of discomfort and strained relations later.

Will you be able to keep your nose out of the beneficiary’s business?
Once you decide that the loan is for a legitimate reason, and choose to go ahead, think of your personal nature. Are you the type that can leave people alone to mind their own business? If not, this may be a recipe for trouble. Imagine this situation – the person who owes you money decides to go on a vacation with his family. Will it bother you that he chose to go for the vacation instead of returning you the money? Will you be someone who will question his every move? If you cannot keep your nose out of the beneficiary’s business, then you should not loan the money, since it is a recipe for surefire disaster.

Can you afford to have a strained relationship with this person?
Finally, you need to remember that no matter how well you have thought this out, where money is involved things have a way of going sour. If that happens, can you afford to have strained relationship with this person? Remember, it will be likely that in such a case you lose both the money and the relationship. So, will it be wise to loan the money or risk you relationship by saying “no” right now.

After all these questions, if you still feel you want to loan the money then please do consider making it a formal arrangement. Put the agreement in writing. If the amount involved is large, use a service like Circle Lending, which specializes in handling the legal documentation and other issues of loans between friends and relatives.

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Middle Class Millionaire said...

Great Post!

I've lent money to friends before and would never do it again! (unless of course I didn't really want them as a friends anymore) but...if you have to these are some great suggestions.


ispf said...

MCM: Yeah, friendship and money dont always mix well. I personally have been lucky that none of my friends hit me for large loans, but have seen my dad take quite a hit and learnt my lesson from his nasty experience.

Marsha said...

Sometimes a friend truly needs a loan. My policy is that if I choose to lend money to a friend, that inside my heart, I don't count on getting the money back.

I don't mean to suggest that it's OK not to pay back loans; only that I can only be at peace with myself if I don't worry about when I'll be repaid. In other words, call it a loan, but consider it a gift -- and then be grateful if and when the recipient decides to repay you. JMO.

Experts on Credit said...

I never loan money to friends and family unless I know I can part with it for good.

Experts on Credit