Lending money to relatives can be the catalyst for destroying many close family bonds. Especially if you’ve opened your heart and your wallet only to have both broken. It happens more times than not. Yet people make loans to loved ones all the time. In fact, Boston-based American Consumer Credit Counseling reports that 82 percent of Americans would lend money to a family member in need.
For one, loaning money is never simple, but when you lend to family, it also has the potential to destroy “solid” relationships, especially when the money isn’t repaid.
When you make the decision to lend money to family or loved ones, be sure to take the following precautions to help ensure that if and when you decide to loan money, it makes sense for all parties involved with the transaction.
- Decide whether you truly can afford to help. One of the biggest mistakes people make is saying “yes” to a loan without thinking it through. Before you lend money, consider what other uses you have planned for that cash. If you intend to lend extra savings you won’t need for a while, making a loan may not impact you. But if you use funds earmarked for emergencies or other important goals, such as upcoming home repairs or funding retirement, you could be putting your own financial security in jeopardy, especially if the loan isn’t repaid.
- Get your spouse’s or partner’s thumbs-up. If you’re married or in a relationship where you’re sharing a bank account, make sure that person is on-board with helping your family member financially. Lending money to a relative not only can strain your cash reserves; if you’re not upfront about your plans, it can strain your marriage, too.
- Lend only what you can afford to lose. Lending money to friends is a gamble, so don’t use cash you absolutely need back. It can help to answer the request with the mindset that you’ll never see the money again. If you put the family relationship first and treat the loan as a gift, then you don’t have to worry about nagging the person for repayment. You also will be pleasantly surprised if the money is actually repaid.
- Put it in writing. If you decide to lend money, spell out the details in a written agreement—and then have it signed and notarized. Seriously. Even if it’s “just” for your mom or favorite cousin. Your written agreement should specify the terms of the loan, including a timeline for repaying the loan, a schedule for making weekly or monthly payments, and what happens if the loan goes unpaid. Having this in writing can help you avoid misunderstandings later on. Additionally, a written promissory note can avoid family disagreements after death. Often, a debtor-child may “forget” that the received amounts were loans and not gifts. A written agreement will allow the beneficiaries to equalize the inheritance by offsetting the amount due and owing against the debtor-child’s share.
- Charge interest, says Uncle Sam. If you’re making a loan and aren’t planning on charging interest, you may want to reconsider. Any interest you waive can be considered a gift to the debtor by the Internal Revenue Service (IRS) and subject to tax if that amount plus any other gifts you made to that same person exceed $14,000 (in 2014). Additionally, the IRS will impute interest to you. In other words, the IRS requires you to treat some of the money as interest— which is taxed as ordinary income—whether you receive it or not. To avoid running afoul of the imputed interest rules, you should charge at least the minimum interest rate set by the IRS (the Applicable Federal Rate), which is published monthly.
- Be creative. Just because a loved one asks you for money, it doesn’t mean you need to give it. There are other things you can do to help. For example, if a nephew asks for help paying off his credit card debt, try teaching him how to make a budget instead. It won’t get him out of financial hot water today, but showing him how to better manage his money will give him the skills he needs to avoid it in the future.
- Learn to say no. It can be difficult to turn down a request for money. After all, you love your family and care about their welfare. But don’t let feelings of guilt cloud your judgment. Instead, make a policy for lending money and then stick to it. That way you won’t be caught in a situation where you feel cornered. And to avoid awkwardness, have a plan for what to say in response to a request; maybe something like: “I’m sorry you’re going through a tough time, but I’m not in a position to help.”
Should you lend money to a relative in a financial crisis? Only you know the answer to this important question. Whatever you decide, the key is to be gentle, sympathetic and clear in your response. If you say “yes,” you’ve set the stage for a good understanding of what the loan entails. If you say “no,” you can help defuse what is likely to be an emotionally charged issue. But either way, you’ll be able to rest easy knowing that you haven’t done something to jeopardize an important relationship.