When somebody you care about is in financial distress and could use your help, chances are you want to do anything within your means to help them get back on track. Unfortunately, sometimes this gesture of good will ends up being detrimental to your relationship with the recipient or to your own finances. Here are a few tips for lending a hand:
If at all possible, consider the money a gift. The safest way to avoid conflict down the road is to consider the money to be gone from the start. If you have any expectations to be paid back in the future, there is a greater chance that your relationship with the borrower may be strained. If you can afford to write the money off as a gift, certified financial planner Robert Schmansky suggests that you do so. He says, “Have the mindset [that] this is money you may not get back. You’re on the hook for whatever it is. Don’t let the financial consequences of this person defaulting or not making payments interfere with your relationship. Giving a gift is a lot better, a lot cleaner.” Manisha Thakor, a personal finance expert and author, agrees with Schmansky, “With family, my personal rule is, ‘Only give if you are willing to not ever get the money back. Commit to yourself that you are aware you might not get the money back. But that is a risk you are willing to take, because love is more important than money.”
If you provide a loan to somebody with the expectation of receiving it back in the future, get it in writing. If you can’t consider the loan a gift, treat the transaction like a bank would. You can have a contract professionally drafted, set up an automatic debit from the borrower’s account, write out payment plan options and keep a running ledger, etc. Schmansky says to, “Set up expectations. That way, the family member isn’t coming back to you in a year saying, ‘Unfortunately, I can’t pay you back.’” Thakor recommends even getting collateral and charging interest. “You can charge a higher interest than you’d get from many savings accounts and still be charging less than the interest on a credit card or bank loan,” she says.
Be clear on terms. Don’t leave any room for interpretation. Do not compromise between a gift and a business transaction. According to Thakor, “If you do anything in between those two, that’s when you’re going to get into trouble. All the horror stories you hear about people lending money to friends and family boil down to ‘it’s kind of a gift or sort of a business transaction.’” Either give the gift without expectations for payback, or declare the money as a loan and set defined parameters for your remittance.
Prioritize your finances. If giving a loan to somebody isn’t in your own finances’ best interest, don’t do it. Be very cautious with how much you give and how often, because you never want to end up in your own financial bind without the money you need to cover your own emergency expenses.
Know when to say no. Don’t be afraid to simply say “no” if somebody approaches you for financial help. You may be better off coaching them through their struggles and offering advice to better their situation rather than compromising your own situation or emergency funds. “Needing money to cover an emergency is one thing. Borrowing money for everyday expenses signals a problem,” MSN Money states. If someone is habitually asking for money to cover basic expenses such as groceries, gas, etc., they need to have their own finances examined rather than being handed money on a regular basis. Perhaps you can sit down with them and work out a budget – if their expenses exceed their income, they may need to find a second job, or find ways to cut costs until they are in a better place financially.
If you have any questions about lending money to others or you would like help with your own financial planning, please give us a call, we’re here to help.