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American novelist Mario Puzo is quoted saying, “Friendship and money: oil and water.” He may not be correct 100% of the time. But he’s got a point.
Mixing relationships and money can have disastrous consequences, ranging from never seeing your $20 again to burning relationships to the ground. And it goes both ways, whether you’re the one borrowing money or the one lending it.
As someone who has borrowed money from family members and lent to friends before, I’ve learned that it’s so important to set good boundaries. Otherwise, you risk money ruining your relationships, which is never a good thing. So before you open your purse strings or hold out your hand, check out our rules for borrowing from and lending to friends and family members.
Rules for Borrowing Money from Friends
Let’s start on the receiving end. Sometimes, borrowing from friends or family members can seem like a more viable option than taking out a personal loan. After all, they’re likely to lend to you for little or no interest. And they know you personally instead of just looking at your credit score or other fairly impersonal data.
You might be in this situation when you’re just starting out, and managing basic finances is tough. Or maybe an emergency arises, and you aren’t sure where else to turn. Borrowing from family or friends, in this case, isn’t always a bad decision. But you need to be sure you go about it properly. Here’s how:
1. Look into other options first
Before you borrow from a friend or family member, look into other options. This could include tracking your spending and getting on a budget. It could mean starting a side gig to earn more money or even asking for a raise. Or you could try negotiating for better rates with your current creditors. You might even look at your options for getting a personal loan through a traditional lender.
There are new players in the personal loans field that, via advanced algorithms, would match your loan demands to the best personal loan quotes with a possibly surprising APR rate. You should check out the following:
This isn’t to say that you should take out a loan with a 17% APR if your parents are willing to lend to you at a much lower rate. But you want to be sure you’re financially prepared to meet your obligations, no matter where you borrow from.
2. Be sure they can afford the loan
This is a time to be very frank about your and your lender’s finances. It may not seem like your business. But if you’re close to your lender–especially if they’re someone like a parent or grandparent who feels responsibility for you–they could lend when they can’t afford it.
You don’t have to ask for a detailed financial statement, of course. That is none of your business. But if your friend or family member struggles with their finances, don’t ask to borrow money.
3. Pay at least some interest
This piece of advice may differ depending on the relationship in question. My parents would lend me money if I did need it (mostly through no fault of my own). But they wouldn’t let me pay them interest. It just wouldn’t occur to them.
However, you should offer to pay enough interest to make up for inflation if you’ll pay the loan back over several months or years. A short-term loan may not require this step unless the lender asks. But for a longer-term loan, be prepared to pay at least 2% – 4% in interest.
4. Don’t negotiate for more
It’s okay to ask for what you need, according to your situation. If you really could use a $10,000 loan, ask. But if your friend can only spare $2,000, take the offer graciously and don’t negotiate. Negotiating is what you do with banks and people with whom you have purely financial transactions. It’s not what you do when you borrow from friends and family.
If you’ve looked at your other options and found them lacking, you’re not really in a position to negotiate, anyway. Look at the loan as a favor, and be gracious about accepting it. Even if it doesn’t meet your total needs, it progresses toward your goal.
5. Set up some paperwork
Never borrow money from a friend or family member with a spit handshake. Written documentation helps keep you both accountable for who owes what and when. Your lender needs to know when to expect payment and when they’ll be fully paid. You’ll need to both agree to these terms, and you’ll need to be sure you stick to them.
One of the best things about borrowing from people who care about you is that you can often set terms that work well for you. Maybe you pay every other week on payday or once a month if you’re paid monthly. Be upfront about what you can afford, but ensure the lender is also getting what they need.
As a side note, you can draw up formal legal paperwork if the lender prefers. But that’s not necessarily required. If the lender wants you to sign legal paperwork for the loan, do it.
6. Make payments on time
If you’ve borrowed from a friend or the Bank of Mom and Dad, it’s tempting to be lazy about making payments on time. Don’t be. In this scenario, your credit score may not be on the line since they won’t likely report your loan to the credit bureaus. But something far more important is on the line: your relationship.
Do what you must remember to make this payment on time. Schedule automatic transfers using your bank’s online check feature. Or set a reminder on your Google calendar and then make payments when they’re due using PayPal’s friends and family transfer feature. Whatever you do, make sure that those payments get made on time.
7. Try to pay it off early
If you’re sticking to the payment plan, this isn’t entirely necessary. But it can be nice. And it can help remove the weight of financial transactions from a relationship. For your friend or family member, getting money back sooner rather than later could be financially helpful. And if nothing else, it buys you back some credibility you may have lost if you got yourself into a financial scrape in the first place.
Even if you only pay the loan off a month or two early, that can still be a nice surprise and a boost to the relationship.
8. Work to maintain the relationship
Finally, be sure that you don’t let this relationship become primarily about financial transactions. Keep maintaining the relationship in the ways that you would have if there were no loan at all. This might mean regular dinners or just holidays together.
There’s a balance here. It can be tempting to pull out of a relationship if you’re embarrassed that you had to ask for money in the first place. But you could also be tempted to ramp up the relationship to “make up” for borrowing the money. Either option could lead to some awkward moments. It’s best to keep on as you were before in the same rhythms–just with that extra monthly or biweekly transaction thrown into the mix.
Rules for Lending Money to Friends and Family
As you might guess, our rules for lending to friends and family are the flip side of the borrowing rules. Lending isn’t always a bad option. It can be a good way to put the money you can spare to use. And it can be a real help to someone you care about. But before you write a check, consider these rules:
1. Only lend what you can afford to lose
This is the most important rule here. If you’re lending money, be sure you can afford to lose it. Think of lending as giving a gift. If you’re paid back on time, it’ll be a surprise gift in the other direction. Getting repaid is just a bonus.
Looking at the loan this way may seem strange. You wouldn’t likely hand someone a large check for their birthday, after all. But holding onto this loan loosely can help you ride potentially emotional waves if the person walks off without repaying you or continues to struggle financially.
2. Count the potential relationship costs
With this said, even if you hold the loan loosely, there are potential relationship costs. Many strong relationships sour over money. It’s easier to replace the money in your bank account than to replace a lifelong friend or close relative. So be sure that the loan is necessary for your friend or family member and worth the potential relationship for you.
Following the other rules here may make it less likely that you’ll lose the relationship over the loan. But it could still happen, so be careful.
3. Talk to the borrower about their other options
Be sure the borrower has vetted other options. This is only possible if you dig into their finances, which you have a right to do as a potential lender. This doesn’t mean you need to interrogate them about every expense. But you should have a good idea of their income and outgoing expenses, whether they’re sticking to a budget, and if they’ve looked at other options.
4. See if there’s another way to help
Sometimes, digging into other options can help you see if there’s another way you can help outside of lending money. For instance, you might find that all the person needs is some budgeting guidance to be financially successful. Or maybe he’s looking for a job, and you can give him some work or help him make connections in your field. There are often alternatives to writing a check, so be sure you explore those in a non-threatening or controlling way.
5. Set a fair interest rate
It’s good for borrowers to have some skin in the game for repaying on a reasonable schedule. And it helps you to get some interest on the loan you’re making. Don’t charge exorbitant interest, of course. After all, the primary goal here is to help a friend not fund your retirement. But look at inflation and set a rate that’s at least a little higher than that.
6. Create a payment schedule
This is a good place to sit down with your borrower’s budget. Figure out what they can afford to repay on a monthly or per-paycheck basis. Then, set that payment schedule and get it in writing. If you want, you can create a formal legal document. Or you can use a spreadsheet to keep track of payments and amortization. Agree on the day you’ll be paid, and then expect payment on that day until the loan is paid off.
7. Treat it like a business transaction
By this, I mean that once you’ve loaned the money, you should treat it like a true personal loan. The bank you borrow from doesn’t give you the third degree about how you spend the money, provided you make payments on time. You shouldn’t either. If you think you’ll take offense to the financial decisions the borrower makes after you make the loan, don’t make the loan at all. You should be fairly confident the money will be used wisely, or you shouldn’t provide it.
8. Don’t lose sight of the relationship
As with being the borrower, when you’re the lender, try to focus on the relationship that already exists. Don’t use a loan to wheedle your way further into the borrower’s life than you were before. And don’t assume that your situation gives you unlimited lifetime access to the borrower’s finances. The borrowing/lending relationship can be handled separately if they’re late on payments. But the rest of your relationship should continue, as much as possible, as it was before.
Lending to and borrowing from friends and family members can be tricky. And it really shouldn’t be your first or preferred option. But it can be a good stopgap if you’re really in a jam or a way to help someone out if you have money to spare. Just follow these rules to keep things as smooth as possible, whether you’re the lender or the borrower.