What to do when friends or relatives ask you for money

It is a fairly common occurrence...a relative in need asks you for a loan or for help with co-signing a loan. You want to help but at the same time you know that lending money to someone you love can turn out badly. Before you consider opening your wallet, think about the possible consequences:

• Can you really afford it? - Don't be tempted to lend someone money when you aren't financially stable yourself. Unless you are debt-free and have an established emergency savings fund, you are not ready to start granting loans to someone else. If an unexpected expense arises, you may be put in the position of having to borrow money yourself.
• Your credit could be damaged by co-signing - In many ways, co-signing on a loan for a friend or relative is much worse than just lending them the money. When you co-sign, you agree to take responsibility for the loan. This means that the monthly payments will appear on your credit report and that you could end up paying for the loan if the borrower defaults.   
• You may never be repaid - Before you lend money to a friend, consider the very real possibility that you will never be repaid. How would this impact your finances? How would you feel? For large amounts of money you may want to work with a lender to formally administer a loan instead of simply working off the honor system.
• Why can't they get the money elsewhere? - Has your friend or relative tried applying for a loan on their own? If they have been unable to obtain financing independently, there is probably a reason. Lenders turn down applicants when it is likely that they would not be able to repay a loan. Are you willing to take a chance on lending money to someone that has already been identified by professionals as a high risk borrower?
• Will it actually help them? - Does lending money to a friend actually help? Consider why your friend or relative needs the money before deciding to lend to them. Is it because they are financially irresponsible or because of a real emergency? In some situations, lending money to a friend or relative is a bad thing because it actually allows them to perpetuate their problems. Instead, offer a creative solution such as dollar-for-dollar matching (Abraham Lincoln once offered this his step-brother) or paying for debt counseling.
• Consider the tax implications - Small loans may not have an impact on your taxes but large loans might. If you are considering lending over $10,000 to a relative, speak with a tax adviser first to see what penalties you may face.

If you decide to lend a friend or relative money after having considered these consequences, keep detailed records of your loan and don't be afraid to ask about repayment. Be very "matter of fact" about tracking the loan from the start. If you make it a policy to send monthly reminders you will feel less awkward and will help your borrower stay on track.

What do you think about lending money to friends or relatives? Is it a gesture of compassion or an instant disaster? Share your feedback and stories in the comments section below.

Comments

[Emma]

I don't make it a habit of lending money to friends or family. If asked, I just give it to them. I always think of 2 things now when this comes up.

First, if I give them the money, is this action enabling them to misbehave in some way, either deceiving a spouse, buying something they can't afford, paying back someone else. If so, I try to help them out, without money.

Second, your relationship changes as soon as you lend money to someone. In Proverbs it states that the "borrower is slave to the lender". Think about the consequences for lending money and if you are willing to lose that relationship for money. Sure, you won't think anything of it, but the friend or relative who borrowed the cash thinks differently of you.