The awkward art of lending money to family members
- Loaning family members money can be messy — only offer as much money as you are able.
- Try applying criteria to loan requests to evaluate the decision (such as, “Will lending this money significantly improve the quality of my family member’s life?”)
- Avoid loaning money if there is a chance that it may ruin a family relationship.
A new survey from Bankrate shows that 46% of Americans who lent cash to a family member either didn’t get the money back or experienced “damaged” relationships with the borrowers.
That’s just the tip of the proverbial family finance iceberg — the study data clearly shows the mounting problems linked to intra-family loans:
• 45% of those who cosigned for a financial product experienced negative consequences (21% had their relationship damaged, 20% said their credit score was hurt, and 18% lost money).
• 37% of those who lent a credit card to a friend or family member had something bad happen (21% lost money, 16% said it harmed their relationship, and 12% took a hit to their credit score).
• Parents of adult children were the most likely to report lending cash (65%), cosigning for loans (29%), and lending their credit card (23%).
• 70% of rewards credit cardholders who tried to accrue credit card rewards by paying for a group bill got burned in the process.
“I’d avoid lending cash and credit cards and co-signing,” says Ted Rossman, Bankrate industry analyst. “All too often, these situations end poorly.”
How to handle a family loan request
Rossman says that it’s “OK to say no” to a loan request from a family member and to provide help “in a different way.”
“If you really want to do it, only offer as much assistance as you can afford to lose,” he says. “In your mind, assume it’s a gift and that you won’t get paid back. Let that sink in ahead of time so that a negative experience doesn’t harm your relationship along with your account balance.”
Other financial experts generally agree with that outlook, but note that if you do go forward with the loan, take special precautions.
“As someone who grew up poor and went on to have a successful career, I’ve been asked for money from family members many times,” says Calvin Rosser, founder and chief executive officer of Life Reimagined, a life enrichment online platform. “In all of the situations for which I’ve agreed to lend money, I’ve been paid back without signing any contracts.”
While Rosser notes that everyone’s family loan situation is different, there are some rules of the road to go by.
“Whenever a family member asks for money, try applying simple criteria to evaluate the decision,” he advises (as follows):
• Will lending this money significantly reduce the quality of my life?
• Will lending this money significantly improve the quality of my family member’s life?
• What is the likelihood that I will be paid back based on the family member’s track record?
• Does giving money in this way align with my values?
By way of example, Rosser says that a few years ago, his cousin was arrested for drug possession. “He called me and said that he needed $2,000,” Rosser says. “He would use the money to pay for a lawyer who would help him get the drug possession charges expunged. Otherwise, he’d have a felony on his record.”
To evaluate the decision, Rosser applied his family loan criteria.
“To start, parting with $2,000 was not going to significantly change the quality of my life,” he says. “Second, my cousin’s life and employment options would be significantly better if the $2,000 got the felony off of his record. So while there was some risk involved, I decided to lend him the cash. I fully accepted that there was a chance that I might not get the money back.”
Before sending the money, Rosser had his cousin do extra diligence on the lawyer he was hiring for his court case. Rosser also had him agree to read three books he recommended to help him get back on track.
“We agreed he would pay me back in six months, but didn’t sign a contract,” he says. “He ended up paying me back in 12 months, and the felony was expunged.”
Rosser’s lesson learned? He says it’s simple. “Giving money to family can be messy, awkward, and difficult,” he says. “It’s up to you to decide the criteria and terms under which you feel comfortable giving.”
As Rosser notes, it’s helpful to keep an open mind on the reasons behind the loan request — it might be for a clear-cut need that will improve the borrower’s life over the long-term.
“Loaning money to family could be a good method of transferring money to the next generation,” says Zach Morris, a financial planner at Paces Ferry Wealth Advisors in Atlanta, Georgia. “For instance, providing a mortgage to an heir at a favorable rate could help them buy their dream home, but not feel the burden of a large month. For the lender, this is a way of providing a benefit to the next generation without using an annual or lifetime gift exemption.”
If there is any doubt or reason to believe that an interfamily loan will go south, it should not be implemented, Morris says. “Doing so is a surefire way to ruin a family relationship,” he says. “If you do go ahead with the loan, get the deal down in writing — just as you would for any loan.”
“We always recommend that clients document a family loan in writing to avoid having it be viewed as a gift by the IRS,” says Morris. “A best practice would be basing the interest rate applied off the Applicable Federal Rates published monthly by the Internal Revenue Service.”
“Outlining penalties will only help to strengthen the case that the loan is not a gift,” Morris adds.
Three useful tips for lending a family member cash
Financial experts say that if you do go forward with a family loan, keep a short list of tips in mind as you proceed. Each should help you better deal with a tough family decision — for you and your borrower.
Don’t expect to get it back. If you look at lending money as a gift to a needy family member, then you won’t risk damaging relationships when the exchange is made, says Chane Steiner, CEO of Crediful, in Scottsdale, Arizona. “Better yet, if they actually do pay you back, it’ll feel like a reward for being a decent family member,” he says.
Don’t lend anything that you need. “We all want to help our family, but if lending a large amount of money will break you, don’t do it,” Steiner says. “Explain to your family member that you are in a tight budget and that you don’t have anything to give. If they feel slighted, offer to help them find work or to go in with them on a side hustle. That way they can understand that you, too, need the money.”
Get out of loaning altogether. Just say, “no,” Steiner advises.
“For example, if you’re a grandparent, explain that you can’t, because if you did it for one grandchild, you’d have to do it for all of them,” he says. “If you’re a sibling, explain that anything extra you have is going to a child’s college fund and wouldn’t they be heartbroken if you had to get into it?”
It’s playing dirty to guilt someone out of asking for money. “That said, to preserve a relationship and not lose your money, it’s more important to turn down a family loan altogether than to get upset when they inevitably go bad,” Steiner says.
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