There are a lot of things to consider when a family member or friend asks you for a loan. Protect yourself from unforeseen circumstances and be smart when considering lending money to family and friends. Consider these helpful guidelines:
Do not dip into your retirement: Loaning money is not a good idea if means you have to risk dipping into your retirement! Protect this as though you were its mother or father! Do not let anyone touch it! Not only could you be at risk of having to pay tax penalties and fees for drawing out of retirement savings too early, you also have the added disadvantage of losing the potential growth of those funds if they were left alone.
Don’t risk more than you can afford to lose: Loaning money to friends and family is a gamble. So, never make a loan if it is going to put your own financial situation at risk! It’s never a good idea to loan money out, but if you do, just keep in mind and have it in your head that you will never see it again. Shorting yourself the money you need to get by day-to-day increases your financial burden, and it can put a strain on the relationship you have with the person to whom you loaned the money.
Consider the reason the borrower needs money: Do they need the money because of an emergency like the loss of job or unexpected medical bills, or because they made poor financial decisions? Will it be used for something that will improve their life? Is it for a down payment? Education? Find out exactly what it is for, and then decide if you want to help them out or not.
Involve your partner or spouse in the decision: Communication could not only save you money, but it could save your relationship or marriage! If your spouse and you don’t agree on making the loan, it could result in stress on your relationship. Consider discussing the situation in depth and come up with a mutual decision together!
Don’t let the borrower pressure you: If the borrower is engaged in a destructive lifestyle, then try to be an emotional support rather than being financially supportive. A better use of your money might be to pay for professional counseling to get to the root of the problem! Rather than bailing them out of their current situation, consider providing them with helpful resources instead. Giving into someone with a destructive lifestyle will not address the underlying issue, it becomes a cycle. Also, more than likely the money you loan out will not even help. The borrower will probably come back for more.
Place all terms into writing: Go online and look for a promissory note form. They offer them for free online. Or, go to see a lawyer to have one written up or provided to you. Each state has its own form. Consider having the document notarized, as this will give you more of a legal standing if the borrower defaults on the loan. This will also make the borrower more accountable and aware that the agreement will not disappear until the loan is paid back in full.
Treat loan as a business contract: Once you have agreed on the amount of the loan, discuss interest, payment, term, due date and late fees. Figure out a monthly payment by including interest. You do this by taking the amount of the loan; multiply it by 2 or 3 %, and that is how you come up with the payment. Then, add in interest if you wish. Make sure you take this seriously, as you are loaning out your personal money! Include all terms in the written contract discussed above.
Consider what will happen if you die before the loan is paid back: Make sure that your agreement states this particular circumstance. Will the loan be forgiven, or will it still be owed? If you loan funds to your child, make sure in the agreement that it states if the loan will be forgiven or if what is owed will be subtracted from the child’s inheritance.
As you can see, you really have to do a lot of thinking before making a decision to lend money to family and friends. It’s never easy, but it’s necessary.