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Should You Loan Money To Family and Friends?

We’ve all been in a vexing financial situation—a major repair on the car,, one of your kids unexpectedly falls and has to go to the hospital, or the air conditioning and water heater both break on the same day. 

Sometimes it can be challenging to come up with the money on the spot, so we turn to family and loved ones. Financially supporting loved ones is a kind gesture, but it can get messy, especially if you don’t set proper boundaries and expectations.

A lack of communication can lead to mistakes, hurt feelings, and strained relationships. At least that’s what a LendingTree survey found. 24% of respondents regretted lending money to a loved one, which makes sense since over one-third of borrowers hadn’t been paid back.

Is there a way to financially support your family without leading to regret? Let’s take a closer look.

Gift or Loan? Yes, There’s A Big Difference

A gift and a loan are two completely different things. Think about the mortgage payment on your home. The bank most certainly didn’t give it to you as a gift. After thoroughly checking your records—credit history, employment history, household income, tax records—they loaned you the money to live in your house. If you consistently miss payments, you risk defaulting on the loan.  If you do default, the papers you signed to get the loan give the bank the right to sell your home to get their money back.  The home is the collateral and that is why mortgages are called “secured loans” - they are secured by the value of the house. 

However, a gift doesn’t have to be paid back (that might make the holidays a bit awkward).

When financially supporting friends or family, you have to be upfront and communicate if and how you want them to pay you back.

  • Are you planning on giving the family member the money or structuring it as a loan? 
  • If it’s the latter, will you expect them to pay interest? 
  • Do you have a specific timeline on when you’d like to have the money paid back? 

The reality is that it’s often simplest to give the money without the expectation of repayment with family and friends. However, if a loan is the route you want to go, treat the transaction like any other business deal and do your best to keep emotions out of the equation.

How best to do this?  Start by asking some fundamental questions:. 

  • Why do they need the money? 
  • Is it a one-time situation or a recurring ask? 
  • Is helping them financially enabling a bad habit or truly offering support? 

For example, if your sister’s dog got into the pantry and ate 3 pounds of baking chocolate and had to get rushed to the vet, followed by a big bill for the emergency operation that saved the pooch.  That’s hopefully a one-time occurrence. However, if your sister needs help paying rent month to month due to credit card bills and there is no plan to get out of debt or reduce the spending, your money is more of a band-aid, not a real solution.

Lending or gifting money to family or friends can get messy, so it’s important to know what you're comfortable with before committing to anything.

Tips To Structure The “Loan”

The first step to structuring a loan is always to get it in writing. For smaller amounts, perhaps it can stay between the parties, but it may make sense to get a lawyer involved for larger amounts.

What if they don’t want a loan and are asking you to be a co-signer instead? Co-signing on a loan can be a good, albeit risky option. Should they default, you would be on the hook for payments. It could also impact your credit score—debt to income ratio—and hurt your chances of procuring a better interest rate on a new loan in the future. Doing so might make sense if they don’t have sufficient credit history to qualify for a loan or don’t earn enough due to a recent job loss or injury to qualify. 

Only “Loan” Money To People You Trust

You work hard for your money, so you shouldn’t give it away to just anyone. Make sure the person you're loaning to is trustworthy, hardworking, and earnest. Ask yourself: are you ok with not getting all or some of your money back? With family and friends, it’s not uncommon for this to happen, so be honest with yourself and understand that reality.

Before you commit to a loan, make sure you can answer all of the 5 W’s and the big H:

  • Who: who are you loaning money to?
  • Why: why do they need the money? 
  • What: what will they do to repay the money?
  • When: when will you receive the money-back in full? 
  • Where: where will your money be coming from?
  • How:  How will you manage if they don’t pay it back?

Procuring sufficient answers to all of these questions will help put the information out in the open. It can provide you more confidence and clarity when deciding to loan the money or not.

Prioritize Your Financial Wellbeing

The number one rule with mixing family and finances: only give what you can afford. 

While that may sound obvious, once emotions get involved, logic muddles; if you have little debt, a solid emergency fund, a steady retirement savings plan, and a consistent cash flow, then you may be in a position to loan or gift. Be honest with yourself and your loved one about what that amount is. 

If you take one thing from this, don’t go into debt to help your loved one. If you have to sacrifice your financial and mental well-being to give or lend money, it’s often not worth it. If you do, you’ll put so much strain on your relationship that it will make it difficult to recover from. It’s not selfish to put your financial health first. 

Set Healthy Money Boundaries

Before you commit to lending money out, you need to establish money boundaries—one of the most challenging boundaries to commit to is open and honest communication. Communicating, in general, is complex, and getting money involved can amplify it.

When you’re loaning out your hard-earned money, talking about finances can no longer be “taboo.” Setting boundaries helps you be open and honest, which means you’re less likely to dole out more than you can afford. 

The Answer You’ve Been Waiting For

Should you loan money to family and friends? It depends. If you can set firm money boundaries, are financially healthy, and set honest expectations, it’s not out of the question. If you want to make sure your finances are in order, get in touch with our team.