Lending money to a friend or family member experiencing financial problems is a sign of good will, but it often results in disagreements and puts most relationships in jeopardy. According to a survey, lending money to family and friends can result in feelings of hurt, guilt, and regret. In this article, we’ve put together tips that you should follow when lending money to friends and family to avoid damaging your relationships and reduce financial risks.
1. Sign a contract
An effective way to avoid misunderstandings when lending money to family and friends is by having a paper trail of your agreement. A contract shows the responsibilities of each party involved and can be used as evidence in a court of law should the borrower not honor the deal. Here are some of the crucial elements a loan contract should include:
You do not have to rely on the traditional pen and paper to sign a loan agreement with friends and family. Adopt digital contracts for easy and quick loan signing solutions.
2. Be selective about who you lend
When lending money with the expectations of getting it back, it is crucial to be selective about who you can loan. Avoid emotional and financial headaches by limiting loans to family and friends you have confidence will pay back what they owe. To determine who to lend your hard-earned money to, you should consider:
If you feel uncomfortable lending money to a specific person, it is okay to say so.
3. Lend what you can afford to lose
The probability of getting your money back when you lend to close friends and family is often minimal. You should register a loan in your mind as a gift, but do not let your friend know, else you will be giving them default permission. Consider loaning as a gamble and avoid loaning more than you are willing to forgive financially or emotionally if your friend or family member defaults.
4. Charge interest
Make your loan relationship with your family and friends professional by charging interest. A family loan agreement allows you to lend money to your loved one at much lower interest rates than traditional lenders. You keep up with inflation and teach your friends and family to be more financially responsible by charging interest.
5. Be clear on the repayment terms
Before the cash changes hands, you must discuss and agree on the repayment terms to avoid any conflicts in the future. Some of the things both parties should agree on include;
a) Repayment timeline
Ensure you agree on the timeline for repayment beforehand. The repayment timeline can be measured in years or a few days; you just have to ascertain that the borrower understands the expectations of paying back the loan. Do not leave a loan, especially to your family and friends, open-ended, or you may never see your money back.
b) The payment frequency
After determining the timeline for repayment when your loved one is expected to pay back all the money, you should set a payment cycle. Consider setting the repayment frequency based on how the borrower earns money. For instance, if your friend receives weekly paychecks, schedule weekly repayments.
c) The loan structure
Once you agree on the repayment timeline and frequency, you should determine how the family member or friend should pay you back the interest and principal. You could consider structuring the loan as interest only, whereby the borrower only pays the interests on the agreed schedule then pays back the principal at the end. Alternatively, you could determine your money’s interest for the entire period, add it to the principal, and then divide the total to the expected period to develop the monthly installments.
6. Be careful about lending your credit
Most people choose to protect themselves and their money by cosigning personal loans for friends and family instead of lending the money themselves. However, this could land you in more financial troubles than you would have anticipated. Cosigning a personal loan means that you are also responsible for the debt, so should your friend or family default, you must bear the burden of clearing the balance. It also affects your credit score as the loan balance, payment history, and inquiry show up on your credit score.
7. Build lending into your budget
The best way to avoid sacrificing your financial wellness through lending is by including it in your budget. If you find that you are often gifting or lending money to family and friends, consider building it in your budget. This helps you plan for the gifts and loans you intend to give while keeping your financial goals and expenses in mind.
8. Do not lend money under pressure
Do not let the sense of obligation force you to lend money when it does not make sense financially. When a friend or relative asks for a loan, avoid saying yes right away. Be sure to request time to review your finances. This gives you time to develop a creative way to turn down their request or find an alternative way of helping them, including directing them to other loan providers or resources that bring them financial relief instead of a loan.
9. Learn to say no
Money is one of the leading causes of failed relationships and friendships. To protect your relationships, learn to say no, especially when you cannot afford it, the purpose of the money does not make sense to you, or when you feel like a pushover. Understand that saying no does not mean that you do not care.
There is no guarantee that money lent to friends and relatives will be repaid or that it won't cause conflicts and disappointments. However, this should not stop you from being there for them when they’re in difficult financial situations. Use the above tips to minimize misunderstandings when lending money to your loved ones.