Should you lend money to a loved one or family member? Maybe your sibling could use help with a down payment, your favorite cousin has hit hard times or a parent who made some bad financial choices now needs assistance.
Your first impulse may be to help out. But conventional wisdom cautions against loaning relatives money: After all, you don’t want to give the impression that you’re the “family ATM” or risk straining family ties. The fact is that there’s no easy answer; mixing family and debt can be complicated. You may feel stuck, because saying no can hurt family relationships.
Before deciding whether or not to help, there are a number of questions and risks to consider, and there are smart ways to deliver your answer. Here are some helpful tips to think through this difficult question and how to reach an understanding that hopefully benefits everyone.
Know It’s a Common Problem
People tend to overspend: The nonprofit Financial Industry Regulatory Authority (FINRA) found that nearly 20% of people spent more than they earned, while 19% had overdrawn their checking accounts at some point. In other words, about one in five people have been beyond broke at some point in their lives.
When that happens, borrowing from family may be as easy as a phone call or an email. And it happens—a lot. Another study found that nearly 75% of Americans had borrowed money from relatives at least once. But here’s the most telling statistic from that survey: More than 20% of people who loaned money to family said they would never do it again.
Carefully Weigh Your Options
While lending to family members is common, the circumstances vary considerably. First, there’s the reputation of the borrower to consider. Does the family member have a track record of squandering money? Do they have unhealthy lifestyle habits? Are they working hard but can’t make ends meet? All family members may not be on equal financial footing, and it’s fine to assess the financial capabilities of the person asking for money.
Talk with your spouse or partner, other family members and a financial advisor. These conversations can help you weigh the pros and cons, to determine whether offering money is the right course of action. Start simple with questions, such as:
● Can you afford to lend money? Take care of yourself and the loved ones in your household first. If lending to family will put your own finances in jeopardy, that’s a big consideration.
● Do you think your relative will pay you back? Think about the relative’s history with money and make an educated guess about whether you’ll see it again.
● What happens if they don’t repay you? You may be OK with this, if the money is going to an important cause like a home loan. But you may feel differently if the loan is spent on something like a vacation.
Saying Yes? Make the Terms Clear
If you agree to the loan, plan out what you’ll say to your relative. You can even write a script for yourself to help stay on track.
Think about whether the terms of the loan or gift need to be put in writing—you could even discuss it with the person asking for the money. Creating structure and paperwork may pave the way for a clearer understanding about what’s expected from everyone. The paperwork can be as simple as a handwritten note you both sign, or it could be a formal document written up by a lawyer.
When you discuss the terms, be prepared for an emotionally charged discussion. But remember that sorting issues out ahead of time can potentially curb problems and hurt feelings down the road.
Start by thinking about these terms:
● Discuss whether this is a loan or a gift. Depending on what you decide, there may be tax implications. According to the IRS, gifts are considered taxable, with the donor paying the tax. There are a few exceptions, such as helping out with tuition or medical expenses.
● Create payback terms. Put numbers down on paper. Decide if the borrower will pay back a certain percentage every week, month or year. And make sure that the borrower understands when each payment is due.
● Consider interest. If this is a substantial “family loan” above $10,000, the IRS Applicable Federal Rates have absolute minimum market rates for the interest a lender can charge a borrower. Whether you make this a loan or a gift, it’s best to discuss tax implications and appropriate payment terms with your financial advisor.
● Would alternative payments work? For new adults, such as graduates trying to establish their careers, can the money be given for services rendered? Maybe there’s a line item in your existing family budget that could be swapped for the gift. If the borrower is willing to mow your lawn, for example, you wouldn’t have to pay for a landscaper.
● Is this loan in lieu of something else? An adult child asking for a loan might be able to borrow against his or her inheritance, for example. If you’re dipping into your retirement savings or estate plan, it would be best to put that in writing.
Saying No? Explain Why
It’s your money, so you have the right to decide that lending to this relative is not the right thing to do. But be prepared for the questions or hurt feelings that might arise by turning down the request. Follow these tips:
● Stay calm. Remember to convey your rationale as clearly as possible.
● Talk about your own finances. Detail the precise financial reasons you’re not comfortable giving the money. Explain how a loan may cause you financial hardship and (if you feel comfortable) detail to your relative what you can and can’t afford. Offering a glimpse into your own financial situation may help them understand it’s not personal.
● Avoid favoritism. Share that you don’t want to show favoritism and would prefer to be fair to other family members.
● Help them find the money elsewhere. Perhaps you can help this relative explore other means of financial assistance, such as financial programs or loans. This allows you to offer emotional support without having to lend money.
Remember, you’re not alone. Carefully examining all the pros and cons—and the ways in which to say yes or no—is the best approach to handling this tricky situation.
There are no simple answers to these questions, and your decision may be complicated. But by working through the steps above, you’ll be in a better place to consider the actual results of your loan or gift.
Katrina Woznicki is a writer based in Los Angeles. Her reporting and essays have appeared in National Geographic Traveler, AFAR, The Washington Post, The Los Angeles Times, The Boston Globe, and U.S. News & World Report, among others.
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