If you’ve ever lent money to a friend or family member hoping to see it again, you’re not alone.
According to Bankrate’s 2019 Lending Money Survey, 60% of Americans have helped loved ones with the expectation of being paid back. Unfortunately, the reality is that you may never see that money again. Worse, you could end up damaging a relationship with someone close to you.
And not only might your relationship be damaged, but your finances can take a hit as well. Of the 2,490 people surveyed by Bankrate, 25% lost money and 6% said their credit score was damaged as a result of lending.
On the surface, lending money to friends and family seems like the right thing to do, especially for people close to you. However, it’s not always worth the risk.
Why You Shouldn’t Lend Money to Friends and Family
People love to help their loved ones when they can, especially their friends and family. While this can work out for both parties, it’s typically a situation you want to avoid for a few reasons.
1. It can strain relationships.
Relationships are one of the most valuable and important commodities we have. Lending money to loved ones can change or damage our most meaningful relationships. Financial educator and coach, Sharita M. Humphrey, has seen this firsthand.
“I’ve seen so many family dynamics change when one family member loans money to another and they don’t pay it back,” she said. “It can make some family members seem as if they have to choose sides because some may be more understanding than others, and the other side is advocating that the person be paid.”
When you lend money to close friends or family, the borrower may feel less inclined to look at a loan the same way they would if they received it from a bank or other lender. There can be a disconnect with expectations between both parties. This usually doesn’t end well for anyone.
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Money has a tendency to complicate relationships, and sometimes the damage done is too much to bear. Stress in close relationships can cause them to sever completely. “Friendships can be altered or even destroyed when one friend lends money to another and they don’t pay back the money that they owe,” says Humphrey.
A loan between close people can be an awkward situation for both parties. “Think about it from the borrower’s side, too,” says financial advisor Brandon Renfro. “If they aren’t able to pay you back, it could embarrass them even if you genuinely aren’t bothered. In that case, it still may be better not to lend to them even if your only goal is to help.”
There is also the possibility that not lending money could negatively affect the relationship. Either way, it’s best to proceed with caution.
2. It can hurt you financially.
Your relationship isn’t the only thing that may be affected when lending money to a friend or family member. Your bank account and credit can take a hit, too.
First, there’s a good chance you’ll never see your money again. Because you have a close relationship, your friend or family member may view the money as a gift instead of a loan. Even if they do know that it’s a loan, they might assume that they don’t have to pay it back, or at least not quickly. While that might not be the case with small loans, for larger amounts, it could affect your savings or future plans.
Second, spotting a friend fifty dollars is different than giving them access to your credit card or cosigning a loan. In fact, the Bankrate survey showed that 17% of people surveyed lent their credit card to a loved one, and 21% cosigned on a loan or other financial agreement. Those are serious decisions that can put you at risk financially if the other party doesn’t make payments. As the co-signer, you are legally bound to pay the debt if they don’t.
Finally, lending money to friends or family members may even affect your tax situation. The gift tax exemption for 2020, set by the IRS, is $15,000. If you lend someone money below the $15,000 mark, it may go unnoticed. However, if you lend more than that amount without charging interest, you will catch the IRS’s attention and it could be deemed a gift that’s applied towards your lifetime gift tax exclusion.
You will have to pay taxes if you go over the lifetime limit, although the $11.4 million lifetime total likely won’t affect most people.
3. You might need the money.
If you have money to lend someone, chances are you already had plans for using it. It could be part of your emergency fund or your savings for a downpayment on a house or a new car. Consider your finances before lending to someone else, particularly if you’ve already earmarked the money for your own goals.
You may not even have extra money to lend someone else without compromising your long-term (or short-term) financial situation. Lending money to a friend could delay or postpone future plans if you aren’t careful. You may have to prioritize yourself and your family. Loaning money isn’t the best option if it will put you in a financial bind, too.
4. It could enable bad financial habits.
Sometimes lending money to loved ones isn’t the best thing we can do for them, especially if they already have difficulty managing their finances. It may offer a short-term fix, but it might not solve their long-term problems.
While it’s important to help them keep their heat on or fix their car, and the loan may do just that, you want them to develop healthy money habits. Knowing how to manage their own money prevents borrowing from becoming a permanent solution and protects your relationship.
Other Ways to Help Friends and Family Without Lending Money
If a family member asks for a loan, they are probably looking for a quick solution to a problem. Depending on the person and your own financial situation, you can say no while still offering to help. It might not be the help they want, but make it clear that it’s the help you can give.
One thing you can do is offer to sit down with them to discuss their finances. Help them set up a budget or look at traditional loan options.
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If they need financial counseling or education, you can offer to help them find and pay for a financial planner or counselor. You can also send them resources or buy them a book or two on money management.
Consider offering your free babysitting services so they can make extra money, or offer to fill up their gas tank or buy them groceries. This kind of tangible assistance can make a big difference for someone in a precarious financial situation.
It’s tough to say no to friends and family. Offering to help in other ways can sometimes soften the blow.
Follow These Rules if You Lend Money to Friends or Family
If you do decide to lend money to someone close to you, following these guidelines can create the best situation for you and the borrower.
Only lend what you can afford to lose. Natalie Briaud Pine, the managing partner of Briaud Financial Advisors, suggests setting low expectations when lending money.
“Only lend money to family when you can afford to lose the entire loan. Most family members are not going to foreclose on a home or take their son/daughter to court over lack of payment on a loan,” she said. “So, you have to go to the place where you don’t see a dime back and are OK.”
Get it in writing. Find a free promissory note online or seek help from a lawyer to create documentation of your loan. It may be worth getting any documents notarized as well.
Having the terms of the loan in writing, including deadlines and expectations for repayment, makes it clear that this is a loan, not a gift. It eliminates any ambiguity or confusion.
Start small. When lending someone money, don’t give them access to your bank account. Give them a small cash loan so they can prove that they’ll pay it back. Just like a credit card issuer increases limits over time based on repayment history, you can do the same.
Don’t let deadlines slide. When you don’t hold your loved ones accountable for repaying their loan, it opens the door for boundaries to be pushed. A payment that’s three days late becomes two weeks late. Paying you back becomes less of a priority because there are no consequences.
If you’ve put the repayment deadlines in writing, make sure you’re enforcing them and putting consequences in place if the deadlines are ignored.
Consider the impact on other family members. Before loaning money, think about the message that sends to other people you love. What kind of precedent does it set? Will other family members expect you to loan them money if they need it? And what happens if the borrower doesn’t pay you back? Others might feel they need to take sides, which can complicate things further.
Consider how it will affect family or friendship dynamics before agreeing to lend money.
Proceed with Caution Before Lending Money to Loved Ones
Use your best judgment if you plan to lend money to a friend or family member. While money holds value, protecting the relationship is what matters most. If you do loan money to someone, be clear with expectations for repayment or choose to gift the money instead.
There’s no one-size-fits-all solution when it comes to family and money. Make the best choice for your specific situation, and move forward cautiously.