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Family Member Ask for a Loan? Proceed With Caution

Family Member Ask for a Loan? Proceed With Caution

By    |   Wednesday, 15 January 2020 04:40 PM

It starts out innocently enough. Your son asks for $100 to cover an oil change for his car; your freelancing sibling reaches out to ask if you can help them make ends meet one month.

But soon, that simple little loan could turn into a bigger problem, spawning hurt feelings, resentment and taking a toll on your own finances.

Even in the best of circumstances, it’s important to take some precautionary steps before you lend money to friends or family. Here’s how to make sure it’s a regret-free process all the way through.

What to Consider Before Lending

Before you grab your wallet, take a second to think about the following three issues.

1] The loan could have an impact on your relationship.

It makes sense that putting a loan between you and a loved one could lead to emotional fallout. But that prediction is not just a hunch: there’s data supporting it, too. In a recent survey, nearly a third of borrowers and lenders alike said the loan led to negative consequences, with “hurt feelings” being the most common response at 14%.

Other survey respondents cited resentment, decreased contact and verbal arguments, and some even admitted the loan did “irreparable harm to the relationship.”

2] Consider how the money is going to be used.

Not all interpersonal loans are created equally, though some are more common than others. The same study found that auto expenses and monthly housing costs were top reasons for borrowing money from friends and family.

While simple cash-in-hand loans are already problematic, things have the potential to get even worse if you loan out your credit card or cosign a formal loan like a mortgage. In that case, if a borrower doesn’t live up to their end of the deal, the lender’s credit history and score are on the line.

3] You might not get the money back — ever.

Though it varies by generation, loans between family members are paid back at a rate of 52.2%-75.5% at best, which means you’re eating at least 25% of the cost on average.

Studies have shown that language used when asking for a loan may be an indicator of whether or not you can expect to get paid back. Borrowers who used phrases like, “promise,” “will pay” and “thank you” are actually less likely to pay you back than borrowers who use money-savvy terms like, “debt-free,” “minimum payment” or “after tax.”

Tips for Successfully Lending Money to Family or Friends

If you’re still leaning toward lending money to your loved ones, stack the odds in your favor with the following five steps.

1] Learn exactly what the loan is for.

If someone is asking to borrow your money, it’s reasonable to ask them what they intend to use it for. While many interpersonal loans are for necessities like housing or medical care costs, knowing exactly what your money is going toward could help you reach a better mutual understanding and avoid contention.

2] Understand what you can actually afford to give.

The majority of borrowers and lenders alike report they’d only deal with interpersonal loans of $500 or less.

But the fact remains that large loans are still sometimes requested, especially by family members (as opposed to friends).

No matter what your loved one needs the money for, it’s important to consider how much you can actually afford to give them — and not to exceed that number. Overlending will only result in not one, but two parties in your family or friend circle being in financial turmoil.

3] Outline terms thoroughly and clearly.

If you go to the bank and take out a loan, it’ll come with a document full of specifics: interest rates, terms, late fees, the works. But interpersonal loans are often casual, leading to misunderstandings that breed the resentment and hurt feelings respondents report.

Rather than simply shelling out the money, sit down and go through the terms of the loan clearly and completely, including what you approve the money to be used for, when you expect to see the money back and any interest you plan to charge. You might set up monthly payments over time or accept a lump sum after a certain set period, but no matter what you agree on, make sure it’s clearly stated.

Consider putting into writing, too; only 19% of Americans actually documented the terms of their interpersonal loans, which may be one reason they’ve got such a bad track record. You can use free online templates to help get you started.

4] Have a plan if your recipient defaults.

While you’re setting out those plans, don’t forget to include a “what if” clause. It might feel awkward, but given the grim repayment stats, you want to take steps to protect your investment.

You might assess a late fee, as banks do, or charge an interest rate that only kicks in after a given grace period. But aside from consequences for the borrower, make a plan for your own finances, too; if you never see that money again, how else can you recover it?

5] Avoid awkwardness by being preemptive.

If your loved one is asking for a loan, chances are good their money mindset could use a little work. And it’s probably not all their fault: Less than half of the 50 states require students to take personal finance courses.

Fortunately, there are a wide variety of free resources online to help a beginner pick up personal finance basics. Even a simple budgeting app could be a big help.

And if you haven’t already, consider creating a more open and positive line of communication around money within your family. Even wealthy parents tend not to talk to their children about finances, and doing so can set the stage for a healthier and holistic understanding of how money works.

Joe Resendiz is a Research Analyst at ValuePenguin, where he focuses on personal finance and credit research to assist consumers. Previously, Joe specialized on public sector and infrastructure financing at Goldman Sachs. He graduated from the University of Texas at Austin with a BBA in Finance.

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If your loved one is asking for a loan, chances are good their money mindset could use a little work. And it’s probably not all their fault: Less than half of the 50 states require students to take personal finance courses.
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Wednesday, 15 January 2020 04:40 PM
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