Lending Money to Friends and Family (the right way!)

Money has a very unique way of spoiling relationships. Because money can be spent in so many different ways and according to different philosophies, money often leads to arguments or disagreements between family members and friends. So what to do when your teenage nephew or less-than-motivated high school buddy approaches you for a loan? While there isn’t exactly a clear-cut answer to this question, there are some guidelines to be followed when considering a personal loan:

Check Yourself. The very first thing you should do when a family member or friend asks you for a loan is to look in the mirror. Consider your financial situation and whether or not you will be able to survive without the money your going to lend. You want to avoid having to prematurely ask for your money back or God forbid have to get a loan from another family member or a bank to cover your situation. When it comes to lending money, make sure you consider your personal financial situation first, so that you don’t send yourself into a a whirlwind of financial need.

Be Nosey. Be sure to ask the obvious question, “For what?” before you proceed any further. Often times when people are in a financial squeeze, they’ll make irresponsible decisions or pursue loans for things they can never pay-back. As the lender, it is your responsibility to ask how the money will be used so that you can determine whether or not the money will be used for a legitimate need. Some people may be uncomfortable asking, but it is absolutely necessary in order for you to make a proper decision.

Go Formal. Money seems to find a way between even the closest relationships. While most loans may seem straightforward, there are usually many different scenarios that should be addressed. While the terms of the loan should be discussed verbally, everything should be documented formally so that there is no chance of confusion or complication in the future. This can be done the old fashion way (on paper) or you can use a fancy tool like LendingKarma.com to keep track of the loan. The most important thing is that both parties sign the document and that you address key aspects of the loan such as the size, interest rate, when payments must be made and how they will be made.

Get Legal. While the loan is indeed personal, it may be subject to control by the IRS. Oddly enough, you can actually be taxed if an interest rate isn’t assigned to the loan. While small loans will typically fall under the radar, it’s a good idea to seek the advice of a CPA (certified public accountant) to make sure that come April 15th, you aren’t stuck with a hefty tax you didn’t expect. Remember, interest rates can vary and can be customized to your situation.

While lending money to family or friends isn’t everyone’s cup of tea, it works in many cultures and is fact one of the only ways for people in developing countries to pull themselves out of poverty. So if you, like our Brazilian friends in the favelas, decide to lend money to a friend or family member, be sure to consider the advice above in order to avoid any future feuds.