One of the most complicated decisions you’ll be faced with on your financial journey is whether to lend money to a family member. Money and family are both tremendously complex subjects filled with conflicting emotions and stress. Adding them together produces a volatile reaction that is likely to blow up in your face. It’s like a bad chemistry experiment.
At least that was my experience. I have lent tens of thousands of dollars to a family member over an 8-year period. I won’t get into all the details today (that will be in a book I will one day publish) but I can say this; lending this family member money killed my relationship with this person and is the source of my financial anxiety that lingers on to this day. I can honestly say it is my biggest regret in life.
I realize my experience with lending money to family is the worst-case scenario. Everyone who has lent money to family has a unique experience. The first lesson I can share is that you should not lend money to a family member unless you are prepared to lose the money AND your relationship with that person.
You might be thinking that if you are prepared to consider the money a gift rather than a loan that your relationship with this person will remain intact. While this is possible, it’s far from a guarantee. If you give a family member a loan and accept you will never see that money again, what happens when that person comes back for a second loan? Or a third? If this person can’t manage their finances, odds are they will be back for more money in the future.
If this family member comes back for more money before they have repaid the original loan you have to make a much more difficult choice. Do you continue to lend them money or do you cut them off?
If you choose to keep “lending” them money you risk being treated like an ATM machine. If this happens, your relationship with this person is likely already dead, you just don’t know it yet.
If you choose not to lend them any more money, you run the risk of alienating this person. After all, you helped them out before and in their eyes, nothing has changed. They may view your change of heart as a betrayal.
Either option is a lose-lose which should make it very clear that lending money to a family member in the first place is a bad idea that should be avoided at all costs. However, I know from experience that is much easier said than done. The natural inclination for most people is to help someone they love, and if that loved one is pressuring you, it can be very difficult to resist.
We all know lending money to a family member is a bad idea but many of you will do it anyway. If you must go through with it, here are some additional tips that I wish I had considered before I lent money to family.
Does this person need a loan, or do they need a financial plan? If the reason they need money is that they have no clue how to manage money, odds are they will be back for more. Instead of lending them money why not offer to help pay for a financial planner to review their finances and give unbiased 3rd party advice on how this person can better manage their finances.
A “fee-only” financial planner is not cheap and paying for their services may cost you more than the price of the loan the family member is asking for. I cannot stress how badly I wish I had chosen this option. It would have saved my relationship with this person, spared me from countless sleepless nights and saved myself tens of thousands of dollars.
If after meeting with a financial planner it turns out this person really does need a loan, I have one more piece of advice before you give them the money.
Specify the exact terms of the loan in writing
I did the stupidest thing possible in this situation. I lent a family member money and told them to “pay me back when they have the money”. It turns out there is a good reason banks require you to sign a contract with painstaking levels of detail that specify the term of the loan, the interest rate on the loan, on what date monthly payments will be made and the consequences of failing to pay back the loan.
The real reason more people don’t put together a formal loan agreement in these situations is that it is very uncomfortable. If a loved one is asking you for money, it is a very uncomfortable situation for everyone involved. The natural inclination is to end the conversation as quickly as possible, which usually means handing over the money with no strings attached.
An easier way to end the conversation is to tell the family member that you need some time to think about it. This will not only give you time to think about whether you want to lend them money, but it will also give you time to draft out the terms of the loan. Specify when you want to be repaid, whether you’ll charge them interest and most importantly what will happen if this person fails to repay you.
You should review the terms of the loan with this person and sign it together. The signature will be more symbolic than legally binding but don’t underestimate the power of this symbolism.
Lending money to a family member was not only the worst financial decision I’ve ever made but the worst decision I’ve made in my life. You should avoid lending money to family members at all costs. If you feel compelled to help explore alternative options to help this person first and specify in writing the terms of the loan.