A friend or a family member is struggling with a financial problem. That person comes to you and asks you to lend money to help him or her get through the crisis. What do you do?
This situation comes up quite often in tight-knit families where relatives have different levels of financial success. A struggling person will often look to a close aunt, cousin, grandparent or any financially stable family member for help in a crisis.
My solution is a hardline one. I don't lend money to family or friends, no matter what. For many people, however, this is an undesirable solution. Perhaps they do want to help, or perhaps they have difficulty saying no.
Here are four important steps to consider if you are thinking about lending money to a family member or friend (or have recently done so).
1. Decide how important repayment of the loan is to you. If a family member or friend comes to you, instead of a financial institution, for a loan, the odds are that the person does not have strong enough credit to seek a loan via traditional means. Like it or not, that means the person has some risk of not being able to repay the loan. So if you give that person money, keep in mind it might not be repaid easily.
Assuming you've already decided to lend your financial assistance, you have to ask yourself how important it is for that person to repay you. Is the relationship more important? Or are you more concerned about repayment? If he or she slips from their scheduled repayment plan, you're going to have to go down one road or another. You're far better off deciding before it gets to that point so that emotions don't get in the way.
2. Get the terms of the loan written down, signed and notarized. If you've decided that you're going to insist on full repayment, draw up an agreement stating the terms of the loan.This is called a promissory note.
Why should you do this instead of just trusting a handshake? A handshake won't stand up to legal efforts if you need to pursue repayment in that fashion -- a promissory note will.
Your best option is to go through this documentation process before ever handing over the money. Require that a promissory note be signed and notarized by both of you before you hand over the money to the other person.
3. If the relationship is more important, think of the loan as a gift. If you've concluded you'd rather have a relationship with this person than get all your money back, shift your thinking about the loan. Consider it a gift rather than a loan.
A gift has no requirements at all for repayment. If a person chooses to repay you, that's up to him or her, but there's no need for to do so.
If money is given as a gift, then you don't have to worry about nagging the person for repayment or moving through legal channels. However, the money you gave to that person must be considered a complete loss.
4. If a loan is unpaid, don't let the issue sit around unresolved. What do you do if a relative or friend has borrowed money from you but isn't repaying you? You need to decide -- and quickly -- whether or not you're simply going to consider the loan a gift or you're going to actively pursue repayment.
The longer you allow the loan to sit there unpaid while you have negative feelings about the situation, the greater the damage you're going to do to your relationship with that person.
Spend some time thinking about whether you want to pursue this legally or you want to just let the whole thing drop and write it off as a gift. The worst thing you can do is let the situation sit around and fester into something that could tear a family apart.
Trent Hamm is the founder of the personal finance website TheSimpleDollar.com, which provides consumers with resources and tools to make informed financial decisions.
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