Is a Relative Hitting You Up for a Loan?

April 30, 2014

The economy during the past several years has left many people strapped for cash. If any of your friends or family are in a tough situation, one place they may turn to remedy their situation is you.

Is it a good idea to lend money to friends and family? If so, what should you consider and how should you carry out the transaction?

Do you have the money? Your lifestyle may indicate that you have plenty of money to share. The reality may be that you have enough for your own needs, but your other assets are in a less liquid state. Don’t feel compelled to find the cash if it isn’t readily available.

Do you want to lend the money? Just because you have it doesn’t mean you want to lend it. There’s a saying that goes, “If you lend money to family and friends, be prepared to lose both.” If that’s the way you feel about it, you have a right to say “no,” and you should do so without feeling guilty.

Are there other options? You may be someone’s easy solution, but you may not be the only solution. If the person requesting help can qualify for a loan from a financial institution, you might direct him to one. If he’s able to pay back a loan, the bank can take the risk. If he isn’t able to repay, do YOU really want to take that risk?

If you decide to make the loan, approach it as an official transaction:

1. Negotiate the rate and terms as you would in any business transaction. You deserve a return on your money, and you’ll be forfeiting a return elsewhere by providing the money here.

2. Prepare an amortization schedule and designate a monthly payment date. Don’t treat this casually, or you’ll encourage the person to fall behind. You might even consider tacking on a late payment charge. That may seem cold, but it’s a business deal, not a gift.

3. Put the agreement in writing. This is good business, and it may save your relationship later. Undocumented agreements get fuzzy over time. If you have it in writing, signed and dated, you won’t have to rely on your memory. The agreement should also acknowledge that legal recourse is an option if the loan is not paid as promised.

4. Consider asking an attorney to draft the loan documentation, especially with sizeable loans, to avoid having the IRS deem the transfer of money a gift. If the loan exceeds $14,000 in 2014 and is not treated as a formal loan, the IRS may impose gift taxes.

If you decide not to make the requested loan, you may be concerned about how the person will take the news. While you don’t owe any explanation, you may find that the denial is accepted more easily if a “because” is attached.

You could say, “Because I don’t have the cash available.” Or, you could explain that you, too, are being affected by this economy.

The one seeking the loan may try again to convince you, but you don’t have to be swayed. Offer alternative ideas and don’t be pressured into doing something that makes you uncomfortable.

If the worst comes to pass and the money you lent is not repaid as promised, what do you do? Be very careful here because your decision will set the precedent for days to come.

One option is to take legal action. If your loan agreement stated this right as advised previously, the action should come as no surprise. You should issue a warning, just as a loan company would. Give borrowers a deadline to make good on their promise and follow through with the legal action if they don’t.

If the agreement was with someone to whom you plan to gift money or leave money at some point, document that the debt is to be repaid before any money is distributed to this person. Notify the borrower about this requirement and put a legal statement with your will or trust documents.

While others may not know about the loan, chances are they’ll find out. This way, at least, the other parties will not be hurt by the irresponsible behavior of the defaulter.

Bottom line: You aren’t a bank, unless you decide to be one. And it is your decision.