If you’ve lived long enough, chances are you’ve encountered similar awkward situations with friends and family. Your child comes to you and wants help with a car or house down payment. A sibling loses their job and asks you to help keep them from losing their house. An old friend wants your help in launching their private consulting business.
In each of these situations, you want to help, but you’re also concerned about losing money. How do you approach the delicate subject of lending money to the people you love?
Financial advisors often say you should never lend more than you can afford to lose. If you do decide to lend money to your loved one, here are a few suggestions to maximize your chances of being repaid.
Set the Terms
When you write a check, be crystal clear whether it’s a gift or a loan. If it’s a loan, when does the borrower have to repay? Stipulate in writing:
1) The dollar amount of the transaction
2) The fact that it’s a loan
3) The time period for repayment and interest rate
If it truly is a loan, make sure you’re charging no less than the applicable federal rate, lest the interest you forego 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 they would get with any other loan.
Know What It Means
Even the best intentions don’t guarantee successful payback. Understand your friend or family member could default on their loan at any time and that your chances of recouping your money could be poor. Could you lose that money and treat it like a gift, or would you never forgive your loved one? Would it affect your friendship or family ties if things went south? Be honest about these questions before entering any sort of financial agreement.
Are You Doing More Harm Than Good?
Ask yourself whether the loan will put the borrower into a lifestyle they can’t 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 awkward future gift/loan expectations given their unsustainable lifestyle? We all want to help those we love, but is giving money the only way to be helpful?
Guiding the Financially Reckless
Sometimes loved ones need a nudge in the right direction. If you’re not in a position to lend them money, you can give them some simple but important questions to consider:
- Ask if they’ve put together a written plan or budget regarding the money they need. Clear, proper preparation will help them be as successful as possible.
- Propose a more conservative approach, such as, “Why not put your money into an interest-bearing account and save for the entire amount you need? Saving instead of leaping will give you experience and confidence in handling finances on your own.”
- Pause. Advise your loved one to sleep on it. Usually the less impulsive we are, the better decisions we make.
- Introduce your loved one to an unbiased financial planner, like Abacus, who can offer feedback based on years of experience (without having to worry about a conflict of interest).
Always Put Your Own Mask On First
Supporting your loved ones in times of financial need—older, younger, and of like age—is an age-old challenge. There aren’t always easy solutions when it comes to lending family money. But there is a number one rule: as financial advisors, we tell clients “always put your own mask on first.” You can’t be of help to anyone else unless you take care of yourself.
Sometimes compromise is key when it comes to family lending. College tuition help is doable, but the entire cost burden doesn’t have to be your responsibility. There’s a growing movement advocating young adults not attending the best (and often most expensive) school to which they’re accepted. Think Malcolm Gladwell’s David and Goliath here. Save money and actually support a more successful school-to-career experience.
There are also ways to lend support to aging parents that do not bust your own bank account. Occasionally, a reverse mortgage is the right choice, and spending down assets in a calculated way isn’t the worst thing that can happen.
Whatever the lending situation is that arises, your financial advisor can help you find a balance in taking care of those around you without losing yourself in the process. You can wrap your family in love, wisdom, support–and yes, sometimes money–without having to feel stuck.