Perhaps you want to help your child with a down payment or help a friend launch their private consulting business. But what if, instead of giving the money as a gift, you’d like to be reimbursed down the line? How do you approach the delicate subject of lending with the people you love?
Financial advisors often say that one should never lend any more than they can afford to lose. But many of us find ourselves in the gray area of wanting to help but not being willing to lose money. Here are some suggestions for structuring a loan to maximize your chances of being repaid.
Set the Terms
When you write a check, be very clear about whether it’s a gift or a loan. If it’s a loan, when does the borrower have to repay? Stipulate in writing the dollar amount of the transaction, the fact that it is a loan, and the time period and rate of interest of the loan. If it is truly a loan, make sure you are charging no less than the applicable federal rate, lest the interest that you forgo be treated as a gift.
Make It Official
Use an online service to track and monitor the loan, such as National Family Mortgage or ZimpleMoney, which facilitate friend and family loans. The borrower sees a bill, just like he or she would with any other loan.
Are You Doing More Harm Than Good?
Ask yourself whether the loan will put the borrower into a lifestyle that they cannot afford. For example, if you help a child with a down payment on a house, will they be able to pay the property taxes, mortgage and other expenses that result? Or are you setting yourself up for many future loans/gifts and them for an unsustainable lifestyle?
Know What It Means
Know that the borrower could default on the loan at any time and that your chances of recouping that money could be poor. Could you lose that money and treat it like a gift, or would you never forgive the borrower? Would it affect your friendship or family ties if things did not go as planned? Think hard about these questions before entering any sort of a financial agreement.
We all want to help those we love, but is giving money the only way that you can be helpful? Even the best of intentions or friendships does not guarantee a successful payback. Make sure you understand all the contingencies before getting into any kind of financial relationship with someone you care about. As a good friend of mine often says, “Trust, but verify.”