Stop Lending Money To Friends and Family

Stop lending money to family and friends

Now before you judge me too harshly, I’m a firmly believe that charity and generosity should be a part of everyone’s financial plan at some point. However, I believe these actions should be executed wisely and with intent.

At some point or another, we all get asked to borrow money. It starts with $1 in the lunchroom as middle schoolers and can progress into hundreds if not thousands of dollars into adulthood. According to a 2019 Bankrate survey, 60% of US adults have loaned money to a friend or family member with the expectation of repayment. However, this generosity comes at a price with a third of lenders claiming that this action has led to lost money, a bad credit score, or damaged relationship. (1)

There are a few reasons why I don’t recommend loaning money to friends or family:

The loans are not fixed with any terms

When you secure a loan from a bank you have to sign off on very strict terms including an interest rate and payment periods. However, when borrowing money from a friend, the terms tend to be open-ended; “pay me back when you can”. That $500 you gave to your cousin Jimmy can be in collections for years at a time.

Owing money puts a strain on relationships

17% of adults who loaned money claimed it harmed their relationship with the borrower. (1) I imagine that if you’re considering helping a friend or family member it’s because you care for this person and want the best for them. However, you are now altering the relationship from friend/family to borrower and lender. You don’t like getting calls from your bank so I can’t imagine that your friend will enjoy receiving your calls if he/she owes you money.

This money doesn’t earn interest

When you invest money whether through stocks, mutual funds, and even peer to peer lending you expect to get a return paid through interest. However, unless you’re assigning interest terms to the loan yourself, you’re not seeing a return on this money.

What about co-signing a loan?

I DO NOT under any circumstances recommend you co-sign a loan with someone who is not your spouse.* A CreditCard.com survey revealed that 38% of co-signers had to pay some or all of the loan because the primary borrower did not. 28% of co-signers experienced a decrease in credit score and 26% claimed the situation damaged their relationship with the primary borrower. (2) Co-signing a loan means you are legally responsible for the payments should the primary borrower default. Failing to repay the loan in a timely fashion can harm your credit score making you ineligible for future loans or reducing your changes at accessing more competitive interest rates. The bank did not feel comfortable with the primary borrower taking on this loan so why should you? This may sound harsh but it’s your name and credit on the line.

But what if you really want to help?

If you really want to help a loved one, I recommend the following tips:

  • Give the money freely without expectation and at your own risk. If you want to loan your friend $500, expect to never see that money again; treat it as a gift.
  • Do not give away any money you can’t afford to lose. You have your own financial priorities that have to be satisfied first before you start giving out money to friends or family.
  • Create a contract. The bank makes you sign novels worth of documents for a single loan so why can’t you ask your friend or family member to sign a single page detailing the terms of the loan? In the contract make note of the primary borrower, the loan amount, payment terms, etc. Have both of you sign it and make copies. In the event this has to escalate to court, at least you have written proof of your agreement. If your friend or family member does not want to sign anything, then that should be a sign for you that is not the best idea.
  • Do not loan to anyone with a shady history of poor financial decisions. We all have that friend who doesn’t budget, lives above his/her means, and is just in general a hot mess when it comes to finances. Do not lend to this person. Let him/her figure out their own financial situation. You’re not only putting yourself in a bad situation, but you’re enabling their reckless behavior.
  • Redirect them to other options. There are other non-traditional options to secure a loan such as peer to peer lending. You can always recommend they pursue an alternative option vs. borrowing from you.

At the end of the day, use your judgement. Generosity is a wonderful thing but don’t allow the relationship with someone to cloud your judgement.

*Signing a loan with your spouse does not eliminate your risk or relieve you from any legal duty to repay the loan in full. It is only my personal belief that signing a loan with a spouse is more inevitable especially if working with joint bank accounts.

Sources

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