“Sarah, do you have ten bucks?” Mindy was at the Starbucks checkout, drink in hand, and again needed money to pay the bill. Let’s see, this was the umpteenth coffee, and last week it was the lunch bill, after she had finished eating. This habit was getting expensive …
“Mom, I have this great idea for a little business. I’ve put together a plan of what I need and it’s not that much. Since I can’t find a job, would you be willing to make me a business start-up loan?” Vanessa had been job hunting diligently since she got her marketing degree from Ohio State last year. Meanwhile, she took any minimum wage and part-time job to bring in money. Back home, living in her room, she contributed time and energy, especially when she couldn’t contribute money.
“They’re going to foreclose on my house, Cindy. Then I don’t know what I’ll do. Steve’s gone, the kids are all upset, my job doesn’t pay enough to carry the house, but I just need some time to sell it so I can get us into something more affordable. You know I’m good for the money, I always have been.” Cindy’s sister Sam was sitting across the breakfast table, picking at the food in front of her with her fork, not even raising her eyes off the plate of cold eggs.
So what do you do when a friend or family member asks you for a loan? Why is it such a touchy topic and why does it stress the relationship so much?
The culprit is the fact that so many of us see “talking about money” as such a taboo.
Because money carries so much emotion, saying “no” to a friend or family member is nearly impossible. Yet, if we were able to have a calm discussion about the request, we might be able to come up with an arrangement that works for everyone. But for it to work, the lender has to be seen as a friendly banker. No more, no less. Free of emotion, everyone can take a deep breath and act like adults.
Instead, there is usually a lot of mumbling, money changes hands and no clear discussion takes place of responsibility, terms, expectations … or much anything else. The result is that we avoid the topic, the situation gets toxic, tensions rise and relationships are skewed.
The Three Key Questions
Regardless of the circumstances of the request, lending money has to start with three key questions:
- What is the magnitude of the loan: minor or major?
- Deep down, do you see it as a loan or as a gift?
- Either way (since the loan may not be repaid), can you afford to lose the money?
Some other considerations:
- Hopefully it’s not just enabling some existing bad behavior.
- Your spouse or partner needs to be part of the decision-making process.
- And you shouldn’t be dipping into your retirement account, no matter how strong the desire to help someone else out.
If we’re talking about coffees, meals and incidentals, we need to decide how important the relationship is to us. If it’s a good friend and “that’s just how she is,” decide if the “loans” are the price of the friendship, since they probably won’t be repaid. You need to decide and be at peace with your decision. If the price is too high, however you measure it, take all emotion out of your voice and simply state that you are no longer able to be her bank. If that destroys the friendship, you’re very sorry. But, for the friendship to be valuable to you, you have to be straight and honest. And then let the chips fall where they may.
Fund My Business
If a family member or very close friend is looking for money for a business, for example, it’s actually easier: business is business. You should have access to their business plan (otherwise, forget it). You could have them sign a promissory note (Internet Legal Research Group offers forms for each state.) Or you could require a share in the business, with a certain amount of control over how the money is spent, but be aware of any liability you take on. (If you’re funding a car purchase, you could agree that you’ll place a lien on it.) Whatever you do, do not co-sign for anything that makes you responsible for more than you lent.
Regardless of the amount, if it’s emergency money for something like food, housing or medical expenses, consider that it is very unlikely that the loan will be repaid. You’d only do it if you had feelings for the borrower and you wanted to help. If it is repaid, consider it a bonus.
The Tax Man
No one thinks of tax implications when they’re lending money, especially to friends and family. But the IRS does expect you to charge a minimum interest rate defined monthly by the Treasury Department. In their eyes, if it’s not an interest-bearing loan, it’s a gift and here you have some leeway: up to $14,000 per person per year as a gift. Beyond that, there’s a 35% gift tax.
Lending Money or Making a Gift?
For any loan of consequence, once you have agreed on the amount of the loan, you should calmly discuss the interest rate, term, payment due date, late fees and consequences of non-payment. You could use a loan calculator to figure out monthly payments, including interest, at sites such as Bank Rate.
Besides formalizing the loan, having all that in writing allows you to write off the loan if the lender ever declares bankruptcy. On the other hand, if you’re unwilling or unable to get it in writing, consider that you’ve probably just made a gift instead of a loan.
Let us know in the Comments section below if you’ve had good or bad experiences lending money to friends or family.
Bio: Sharon O’Day fixes financial lives. She is a tell-it-like-it-is money expert with a successful career in global finance, plus an MBA from the Wharton School. Today she specializes in getting entrepreneurial women over 50 back on their game so they can have more money, less stress and more joy. With her “Over Fifty and Financially Free” strategies, they take actions that lead to their ultimate goal: financial peace of mind.