How to lend money to family and friends
This is a scenario that many of us know: being asked for a loan from someone dear to you.…
It’s a scenario that many of us are familiar with: being asked for a loan from someone dear to you. And now you have to decide if you want to lend money to this family member or to a friend.
Of course, you already know the main reasons for not lending money to a friend or relative, especially a large amount. You may not get your money back, and if you’re struggling to get your money back, your relationship may crack under the pressure.
But if you’re still considering extending credit, before you write that check – or transfer money – here are some considerations so you and your borrower can talk to each other.
– Tell your friend or relative that you will think about it.
– Examine your finances before making a loan.
– Put everything in writing.
– Consider setting the debt payment plan to automatic payment.
– Understand the legal and fiscal consequences.
– Consider whether to charge interest.
– Learn to say no next time.
[See: Money Moves You Will Be Thankful For.]
Tell your loved one you’ll think about it
If a loved one asks you for a loan, ideally don’t say yes right away. Tell the parent that you will need to review your budget first. In other words, don’t lend money under pressure.
Telling your relative or friend that you’ll think about it can also give you the opportunity to come up with a kind and creative way to say no. Of course, you can decide to take the loan. Yet whether this request is for $ 50, $ 500, $ 5,000 or more, you deserve some space to think about it.
Also, don’t be afraid to ask what the money will be used for. There is a good chance that your family member will voluntarily pass on the information. But if not, you have every right to ask.
Look at it this way: While a bank isn’t likely to ask what a customer intends to do with a personal loan, a bank will typically ask how a business loan will be spent. Until then, you are not a bank. Which means you don’t have to give a loan, so it’s reasonable to ask how the money will be spent.
Take a look at your finances before you take out a loan
So someone asked you for a loan and you said you would look at your budget first.
Take a look at your financial situation and see how lending money would affect you, especially if the friend or relative is taking their time to pay you back. If you can’t afford to lose this money, you are taking a terrible risk.
If you don’t feel like your finances are healthy, that’s one more reason to say no.
Get it all in writing
You and your borrower need to decide on a repayment plan – and, yes, 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 he’s already loaned his girlfriend money and they’ve written it down. And since they got married, we’ll assume that’s good advice.
Wiedman suggests putting everything related to the loan in your written agreement: “The date of the loan, the amount of the loan, the repayment terms, the interest rate, the due dates for payments, etc.”
That said, putting everything in writing can make things difficult, warns Wiedman. The signing of a promissory note didn’t bother his future fiancée, but when her older sister found out about the written loan agreement, it made a lot of noise, according to Wiedman.
“This Thanksgiving, the dinner table seemed pretty tight – at least to me,” he says.
Consider setting the debt payment plan to automatic payment
Maggie Germano, a financial coach for women based in Syracuse, New York, agrees that it’s critical to get everything in writing when a family member lends money to another family member. But she has an idea you’ll want to include in the plan.
When Germano’s stepfather offered to pay off his son’s student loans, “so that my husband doesn’t have to waste any more money on interest,” they did something very smart.
“So they agreed to a payment plan,” Germano says, “and my husband set up automatic payments to his father through his bank account. ”
He never missed a payment, she says, and he eventually paid off the loan. During this time, they never had any arguments or even conversations about the loan as the payments were automatic and transparent.
While setting up automatic withdrawals to pay off a parent probably won’t work for everyone (especially if the borrower has sporadic cash flow), it may work well for someone with a regular salary.
Having such a system also saves the borrower from being criticized for, say, the way they spend money while still owing the family member.
[READ: Gift Tax: Tax Rules to Know if You Give or Receive Cash.]
Understand the legal and tax consequences
Is it legal to lend money to family and friends? Yes. That said, there are some tricky legal loopholes that elderly parents should be aware of when lending money to an adult child.
Patrick Simasko, senior lawyer and wealth preservation specialist at Simasko Law in Mount Clemens, Michigan, points out that “if you lend your child money and have to go to a nursing home and apply for Medicaid in for the next five years, your child must return the money to you. If they are unable and can never return the money, serious Medicaid divestment penalties will apply. Medicaid will treat it like a gift.
You should also think about the Internal Revenue Service, at least a little, according to Neel Shah, estate planning attorney at Shah & Associates and certified financial planner and owner of Beacon Wealth Solutions in Monroe, New Jersey.
“Typically, the IRS believes that no one gets something for nothing. When money or anything of value is transferred to a friend or family member, it will either be a gift, loan, or sale. Each of these elements would have associated tax consequences, ”explains Shah.
For example, Shah says if you lend enough that you end up reporting the loan on your taxes, the IRS would assume that interest would be charged.
“Even if there is no interest actually charged, you can deal with imputed interest income – when the government assumes the interest rate has been charged and charges you accordingly,” he says.
Yet Shah deals with wealthy clients who sometimes loan large sums of money to family members and friends. If you lend your sister a few hundred dollars so that she can pay her rent, you don’t risk breaking the IRS.
Consider whether to charge interest
Charging interest on your loan is definitely your right. The amount of that interest is up to you, but you probably wouldn’t want to charge more than a bank. Typically, lenders charge between 3% friendly and 36% obscene. If it’s a family member or friend, you should probably keep a low profile.
Still, don’t spend that interest until you get it, and better yet, don’t plan on getting it.
“I never make interest rate recommendations,” says Simasko. “If you are preparing to lend money to a friend or family member, the only thing you need to be prepared for is never to get that money back. ”
In other words, he says, “only lend what you can afford to lose. If you find yourself in the situation knowing that you probably won’t see the money again, you won’t be disappointed if you don’t get it back.
[Read: Best Personal Loans.]
Learn to say no next time
If you feel like a cinch and your family and friends still treat you like a bank (and in this case, asking for interest is probably a good idea), then you might need to ‘a strategy to start saying no.
Just be honest and firm and say you’re making a new policy – you can’t lend money to a friend or family member.
Some people have no problem saying no. Others naturally find it difficult to refuse a loan to a loved one or friend. But saying no doesn’t mean you don’t care.
You just might not want to hurt your relationship.
“I have seen relationships completely ravaged by money lending. Entire families have been destroyed, ”says Simasko. “If you’re in a situation where you can’t afford to lose money, just explain it to a family member or friend. Communication is the key. If they really understand that you are unable to lend the money, then everything should be well received.
Of course, that’s when you’re able to lend money – and your family member or friend knows – that’s when it can be really hard to say no.
Still, you have to do what’s right for you, and it’s your money, and therefore you should feel free to make whatever decision you want, without the guilt. Again, it’s your money to do with what you want. That is, unless you lend it to a family member or friend. And then it’s theirs.
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How to lend money to family and friends originally appeared on usnews.com
Update 9/27/21: This story was posted at an earlier date and has been updated with new information.