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Loaning money to friends or family? Make sure of this first, says financial planner

"Only lend what you're comfortable losing."

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Twenty/20

The end of the year brings with it the season of giving, and while many Americans have been lucky enough to have boosted their wealth during the pandemic, many others continue to struggle. If you're in the more fortunate camp, you may find yourself on the receiving end of what can be a tricky request: lending money to a friend or loved one.  

Everyone would love to help out a friend in need in theory, but the reality can be a difficult one to navigate, both in terms of your finances and the boundaries of your relationship. "It's a noble endeavor to want to give to friends and family and help them," says Amy Richardson, a certified financial planner with Schwab Intelligent Portfolios Premium. "But you have to make sure that any giving is within the parameters of keeping your finances intact."

Even if a default on a personal loan wouldn't put a strain on your finances, you could still run into relationship trouble, Thomas Farley, a national etiquette expert also known as Mister Manners, points out. "If you're seeking to end a friendship, asking for money or not paying it back is a great way to do so," he says.

Here's how the experts suggest you handle loan requests from family or friends in order to preserve your relationships and your financial plans.

Considering making a personal loan? 'Put yourself first'

Before you enter into any financial agreement, no matter how close the friend or relative, consider your own standing, says Richardson. "You might think you're in a position to loan the money out, but you have to think, 'Do I need these funds repaid to make sure, for instance, that my retirement is on track?'" she says.

"You have to put yourself first. It sounds odd, but it puts you in a better mental and emotional state to enjoy the act of giving."

In other words, she says, you have to consider the possibility of what could happen to your financial situation if this person doesn't pay you back. "Only lend what you're comfortable losing," she says.

Hiring a professional to take a glance at your finances might not be a bad idea, she adds. "They're going to be able to take a look at your comprehensive financial situation and determine what would really happen to your financial picture if you didn't get the money back."

If that sounds a bit fraught, it's within the bounds of good etiquette to dismiss requests for loans outright, says Farley — even if you have the money to give. "You shouldn't feel as though you have to explain yourself, even if you're well-off, because this is an outsize request," he says. "I would be gracious and acknowledge that you're empathetic. But you can say that it is your personal policy not to lend to friends or family because of the way that you've seen it have a negative impact on relationships in the past."

Remember: Lending money is 'a business transaction'

Even if you have the money to give and would be delighted to help a friend in need, making a money-smart loan isn't as simple as driving your buddy to your nearest ATM. "You need to consider this like a business transaction," says Richardson. "A lender wouldn't give you a mortgage without laying out the terms. It's not just, 'Hey, we hope you pay this back.'"

Anyone who has watched a single episode of "Judge Judy" knows what ought to be done in order to set terms. "There needs to be a written agreement between the two individuals that includes the amount of money being lent, whether there is interest or not, and when and how the funds are going to be paid back," says Farley.

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"While that may seem overly formal or not terribly friendly, in the interest of preserving the friendship, having something in writing is vital," Farley says.

By getting everything in writing, you eliminate the ambiguity that could lead to an emotionally charged situation down the line, Richardson notes. "You don't want to get into a situation where you're saying, 'We verbally said this' or 'I was under the impression that I could do that,'" she says. "If you're both clear that you agree to those terms, it can make lending money much more palatable."

Not getting your money back? Consider alternatives

When you lend to a loved one, be prepared for the possibility that the money you gave them is gone forever. After all, you're not a bank — you're not going to repossess your buddy's car if he defaults on your loan. And while taking someone you know to court is always an option to recoup your money, it seems unlikely that you and your sister are going out for margaritas after you leave the courthouse.

So if it comes time for the loan to be paid back and the recipient is unable to repay their debt, open and honest communication is key if the relationship is to be preserved, experts say. That could mean the terms of the loan change, offers Richardson. "If I was going to pay you back $500 a month and things didn't work out, maybe we see if we can drop the terms down to $250 and extend the length of the loan," she says.

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There may be ways for the other party to pay you back that don't involve money, says Farley. "That person may have a skill or professional service that they're willing to offer as partial compensation," he says. "Maybe, randomly, the person who lent the money is a cluttered mess and the recipient is a great organizer. Or maybe someone could offer to babysit."

If you're looking to avoid thorny money issues from the outset, experts suggest looking for other ways to contribute to a friend or relative going through a hard time. This could include offering to help an unemployed friend with their job search, for instance, says Richardson. "Expand how you think about how you give to and support people," she says. "The best support is not always monetary."

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