5 rules why you should never loan money to friends or family

Fifteen years ago, I learned a lesson about lending money the hard way. A relative of mine hit difficult times in their finances and asked me for a $10,000 loan. You might be familiar with the situation. The family hit hard times, mostly from their own doing. Job layoff. Financially damaging relationship. Overspending on luxury goods and trips they couldn’t afford. 

So, why ask me for a loan? Or better yet, why not me? They knew my family was having financial success. They knew we had just bought a big house. Nobody ever takes your money as seriously as their own money.  

I’ll never forget what he asked me. "I just need a small loan of $10,000 to get me through this patch and I promise that I’ll repay you in the next few months." With one of the biggest mistakes of my life, I told him yes to the $10,000 loan. 

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No thank you note. No thank you e-mail. No follow up after my money hit his bank account. A few months later, things just got weirder. No follow-up. No payback plans. No communication at all. At our family Thanksgiving festivities, not even a mention of the loan at all.  

Shakespeare wrote, ‘Neither a borrower nor a lender be.’ That's a good guide or at least you could listen to Nancy Reagan. (iStock)

All I kept thinking was, "when is he going to just tell me where we are at and when I’ll get my money back?" After Thanksgiving and beyond … just crickets. From that point forward, our relationship became increasingly strained to the point that he never recovered financially, and I never recovered emotionally. So, we just don’t talk anymore. 

Here are some rules to follow for loans with friends or family: 

RULE 1 

Adopt a Nancy Reagan '80s slogan of, "Just Say No!" It is best to tell people you don’t have it; you can’t afford it, or you simply don’t want to jeopardize your relationship with them. Those answers will solve 90% of the problems you’ll have with loaning people money. 

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RULE 2 

You’ll feel better if you just call it what it is, which is a gift. If it is a gift, then you don’t quite have the same level of pressure because, essentially, you are saying that you’ll give somebody money with no strings attached. That means you could be helping a friend through a tough time or a family member who is having trouble paying for their kids’ college. You might feel better about it. 

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RULE 3 

Make it official. The challenge becomes when you do an unofficial loan. This means you may not be clear about the terms of the loan (i.e. interest rate, repayment terms). Now, imagine this scenario. You loan money to a friend or a family member (much like an "Everybody Loves Raymond" episode), and then they book themselves a four-day trip to Las Vegas.  

Then, every time you see them at any event, you’ll always be wondering in the back of your head … "When am I going to get my money back?" You should get a legal contract in place in terms of a promissory note, so you have documentation. 

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RULE 4 

It’s business now, get ready for the relationship to be strained if they miss payments. If the loan goes south and your friend cannot pay it back, how will you handle the relationship going forward? Almost 50% of the adults who lent money to friends or family report having a negative outcome, 37% said that they lost money, and 21% experienced a damaged relationship with the borrower.  

Adopt a Nancy Reagan ‘80s slogan of, "Just Say No!" It is best to tell people you don’t have it; you can’t afford it, or you simply don’t want to jeopardize your relationship with them. Those answers will solve 90% of the problems you’ll have with loaning people money. 

RULE 5: 

No co-signing a loan. Period.  When you co-sign a loan, it isn’t just about lending your credit reputation to help somebody else. It’s an actual financial commitment and a promise to repay their loan if they are unable to do so. This could include late fees, collection costs, and potentially wreak havoc on your credit score. 

If you keep hearing the line from someone that you loaned money, "Don’t worry, I’ll repay you soon!" You might just get caught between whether you write off the loan or write off the friendship.   

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