When a family member or a friend is in need of financial help, they might come to you for assistance rather than a traditional bank. While these loans can be extremely beneficial for all parties involved, they can also be a source of tension or even hostility if things don't go according to plan.
If you are thinking about lending money to a family or friend, consider the following advice and the possible consequences in order to protect your finances, as well as your relationships.
Make it Official
If you are loaning money to a loved one, set specific terms for the loan that everybody can agree to. Discuss how much money will be loaned, interest rates, and how long they will have to pay it back. You can create an amortization table that will help you calculate the various factors involved with loaning money.
Sign the Paperwork
In order to make your loan agreement legally binding, both the lender and the borrower must sign documents that outline the specific terms of the agreement. You can choose to have a lawyer draw up these documents or find a contract online that fits your needs. Either way, having one can help to protect your investment and avoid contention among family members.
Assume You Won't Get Paid Back
A good rule of thumb with any personal loan like this is to assume you won't get your money back, or that repayment will take much longer than expected. Even if you are loaning money to a financially stable and trustworthy family member, things can happen that prevent them from paying you back as originally planned.
After all, a family member is always the last one to be paid back…falling in line behind the mortgage company, the credit cards, the auto loans, etc.
Prepare yourself for this scenario by not lending anything you can't afford to lose. This will also help to decrease any tensions that commonly arise in these delicate situations.
A final thought: I have made several loans to friends and family and in most cases it ended up to be a win-win. However, I have had one loan that has not been paid back … and for some reason I have not heard from that friend. In another instance it took much longer than planned and even created some tense moments. Even though loaning money to a loved one can be beneficial for the whole family, it can also create unnecessary tension and grief. Weigh the pros and cons carefully before loaning your hard-earned money to ensure the financial success of everybody involved.
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