Should You Lend Money to a Relative?
If there’s any chance of endangering your relationship, don’t engage in family banking, says expert
By Deborah Jeanne Sergeant
Family banking seems easier, as it’s simpler to get approval and the interest rates (if any!) are much lower.
But before you receive or hand over cash, consider the facts related to the transaction.
One major requirement is that the borrower be free of any existing addictive behaviors such as substance use, alcoholism or problem gambling. Avoid lending to this family member.
It also pays to closely scrutinize borrowers’ personal ethics, such as their honesty, decision-making skills and appreciation to the lender. A borrower who feels “owed” this opportunity isn’t a safe bet.
The borrower and lender should agree on fair and reasonable terms for the loan, such as a day of the month that payments will be made, method of repayment (such as cash, checks or bank transfers), interest charged and the timeline for repayment.
Why does the borrower want the money? Think carefully before agreeing to borrow or lend among family members.
Is the potential for strife worthwhile? If it’s done carefully, families can benefit each other by obtaining lower interest rates than banks charge and the lender receiving a higher rate of return than leaving the money in a savings account.
Delise Whitfield, financial representative with Primerica Financial Services in Rochester, has some well-off clients who want to bequeath a sum to each grandchild, but lend or gift it before they die so the youngsters can use it for their pressing needs. The grandparents typically decide what they want to give and divide it by the number of grandkids, placing the funds in trusts or giving it outright.
She thinks that a formal loan can be a good idea, but it should be in writing and not a verbal agreement, as misunderstandings and miscommunication can muddy the waters.
“It does need to be someone they’re at least 70% sure they’ll get the money back, especially if it’s $10,000 or more,” Whitfield said.
A written contract with stated interest rates, payment plan and schedule for payoff can help borrowers take a loan more seriously.
Lending to family should not restrict the lender’s budget.
“Only loan what you’re able to give,” Whitfield said. “My biggest rule is don’t loan any money you expect back. If they get it back, wonderful. But if it will put you in a financial strain or cause a rift within the family, it’s better to say you don’t have it.”
She added that it’s especially true for retirees who don’t have any additional earned income. Instead of lending, encourage the would-be borrower to get a part-time gig. If you loan money now, “they’ll continue to ask and other family members will start to ask as well,” Whitfield said. “The cost of living has increased over the past four to five years. The risk of running out of money is very concerning for this generation of retirees. The fact that they may not have enough as it is, shelling money out to people is not the best idea.”
Jeff Feldman, Ph.D., certified financial professional at Rochester Financial Services in Pittsford, encourages potential lenders to only lend if they care about the borrower, knowing they may not get it back.
“If you’re lending to help someone get a lower interest rate and you know you will get it back, it can work out fine,” Feldman said.
He also reminded that if you charge interest on a family loan, you have to declare that on your taxes.
“If you gift under $19,000 to another individual, you don’t have to file a gift tax return,” Feldman said. “It may be easier to loan without interest and then receive the payback as a gift. Talk with an accountant on the rules of gifting versus loaning.”
One of the caveats of giving a monetary gift or loan is that the recipient may choose to do something with the money that you don’t approve of. If there’s nothing in writing, the recipient may decide to use the funds for a different purpose than initially indicated. Unlike borrowing from a bank, in family lending, a lender may be judging how the borrower spends money such as taking a vacation instead of paying more money on the loan.
“You should gift money without any conditions,” Feldman said. “If they do use the money for a car instead of college, you have to know you gave them the money so they can do with it what they want. It might deter you from gifting in the future.”
Planning the arrangement makes a big difference. Oftentimes, informal lending among family members leads to misunderstanding.
If there’s any chance of endangering your relationship, don’t engage in family banking. Financial matters are very personal.
“Even the topic of money tends to activate complicated feelings,” said Erica Randall Lacey, Ph.D., a licensed clinical social worker who teaches clinical mental health counseling at Le Moyne College in Syracuse. “The borrower may feel embarrassment, shame or guilt for asking. The lender may feel pressure to help out of care or obligation, even if they are not in a position to do so. Those feelings alone can shift how relatives see each other.”
She views family banking as a means of possibly shifting relationship dynamics or reactivate former roles such as the “responsible one” or “the irresponsible one or “the rescuer.” The expectations can carry over to other areas of life.
Planning the arrangement makes a big difference. Lacey said that often, informal lending among family members leads to misunderstanding.
Unlike borrowing from a bank, in family lending, “a lender may feel entitled to monitor or judge the borrower’s choices,” Lacey said.
The lender may judge how the borrower spends money such as taking a vacation instead of paying more money on the loan.
“If payments are late or never come, the emotional impact can be much larger than the financial one,” Lacey added. “The lender may feel resentful or taken advantage of. The borrower may feel ashamed or avoidant, pulling back from family gatherings or contact.”