Question: Our son and daughter in-law have asked us for a loan. What should we do?
Answer: It’s not uncommon, especially in difficult economic times, to have a family member or a friend ask to borrow money.
While some people decide against the idea altogether, there may be circumstances where you feel it’s worth the risk. I’m going to give you a few points to keep in mind when trying to decide whether to loan money to loved ones and how to structure personal loans.
Making the Decision to Loan Money
1. Protect your own finances. Review your own financial status so you know how much you can truly afford to lend. As a part pf this, consider how your finances would be impacted if the loan was not paid back. Your generosity could backfire if you lend at a level that puts you in jeopardy of falling behind on your obligations.
2. Clarify the purpose. It’s reasonable to ask why the borrowed funds are needed. You will want to distinguish between tiding someone over during a period of unemployment rather than buying them a larger television.
3. Encourage money skills. If you’re dealing with someone who has chronic money troubles, they may need stronger financial skills instead of more cash. Do your adult kids have a “failure to launch” situation? if so, whether you lend money or not, offer to help them develop a budget or suggest free classes they can take at a local library or community center. Buy them a session with a money coach or financial planner that specializes in money behaviors, credit and budgets.
4. Provide other forms of support. Think creatively about all your options. What could you offer in lieu of cash? Could you offer to babysit your grandchildren if the lack of child care is interfering with your children’s job search?
5. Consider family dynamics. Favoritism or the perception of it can alienate family members. There may be valid reasons for treating individual children differently, but seek to treat them all equitably.
6. Think of how you will feel after making the loan. You can’t control the actions of someone just because you loaned them money. So be honest with yourself. Will you be able to lend this money and not meddle? If you are going to critique their other expenditures while they owe you money, you may both be better off if you decline their request in the first place.
7. Understand your intentions. It’s curious why people complain about someone buying their affections when they appeared to be willing to sell them. Still, you’re better off with people who value you sincerely.
Structuring A Personal Loan
After you’ve considered the situation, if you decide to lend money you should formalize the lending to protect all parties involved:
1. Put it in writing. Draft a promissory note. You can find many simple templates online. Include the amount of the loan and the payment terms. If you amend your agreement, put those changes in writing too.
2. Calculate interest. Determine the rate and how it is calculated on the loan. Recognize that you will most likely need to report this on your tax return as interest income.
3. Consider consulting a professional adviser. Tax attorneys and accountants can advise you on your individual circumstances. This is especially important for larger loan amounts which might trigger other unintended consequences in your financial situation.
4. Provide receipts. Write out a receipt for every loan payment. Keep a copy for yourself and give one to the borrower. It will help you both to stay on track and provide documentation if any misunderstandings arise.
5. Avoid co-signing. Unless there are extraordinary reasons to justify it, co-signing for a loan is often an unacceptable risk. You wind up liable for the full amount if the borrower fails to pay. Even if they pay late, your credit rating will be hurt.
6. Maintain privacy. Keep the details of the loan limited to those directly involved. That usually includes you, the borrower, and any professional advisers.
7. Plan ahead for losses. Know in advance what you’ll do if your loved one fails to pay you back. For your peace of mind, you may decide it’s best to write off the loss. There are tax consequences for the borrower, however, when their is a write off. So you may want to make sure they understand the impact.
Proceed with caution
Protect your finances and relationships by treading carefully with loans to family and friends. Take sensible precautions and always look for alternative ways to help out.