Lending money to friends or family seems like an obvious and easy way to prove you are there for your loved ones. You can show that you understand that life today is expensive as the cost of living continues to increase, and let’s face it, emergencies always spring up.
You are an easy call away and want to help. There's no paperwork or credit checks, and the interest rate is usually zero. Seems pretty simple, right? Nope. It’s not so simple.
What feels like a lifeline can quickly turn into a minefield of emotional tension and broken trust that can cause great schisms, even in the closest of relationships.
From just $107.88 $24.99 for Kiplinger Personal Finance
Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
The Kiplinger Building Wealth program handpicks financial advisers and business owners from around the world to share retirement, estate planning and tax strategies to preserve and grow your wealth. These experts, who never pay for inclusion on the site, include professional wealth managers, fiduciary financial planners, CPAs and lawyers. Most of them have certifications including CFP®, ChFC®, IAR, AIF®, CDFA® and more, and their stellar records can be checked through the SEC or FINRA.
A little help for your friends
It’s challenging to get statistics on how much is borrowed privately, because people don’t have to report these situations. The Federal Reserve does report on national household debt from major lenders, including banks, credit cards, mortgages, etc., but it does not monitor private loans. There are also peer-to-peer lending platforms.
Consequently, clear numbers on this don’t exist. An older study by Finder.com estimated that the Bank of Friends and Family lent $184 billion annually. It also estimated that the average loan was $3,239.
Was the process easy and did the loans get repaid? According to a FinanceBuzz survey, only 56% of lenders were fully paid back by family members. Ouch. A bank would never be in that business.
Even with delinquency rates rising, with a potential recession looming, the Mortgage Bankers Association reports that mortgage delinquencies now stand at a little over 4%. U.S. News & World Report also reports that personal loan delinquencies from financial institutions are at 3.5%.
Pitfalls in a money pit
Just think of the emotional baggage that goes along with friends and family not paying back their loans. How many times does your spouse remind you of the money you lent? How do you pretend to be jovial around the borrowers at the holidays after they’ve stiffed you?
You may cringe when you replay their words. “I need the money for only a few months, and of course I’ll pay it back … with interest.”
Strained relationships may go both ways. The borrower may resent the net worth of the lender and may feel victimized, beholden or patronized. This can all cause divisions within families as one or the other party may feel taken advantage of.
This is all very real. According to the FinanceBuzz survey, nearly 1 in 4 lenders say that giving money to a family member had a negative impact on their relationship with the borrower.
The uncomfortable money dance
It can be an awkward situation for all parties when a loved one asks to borrow money. They may not want to explain why they need it, and they certainly don’t want to beg.
You, as the lender, may also feel uncomfortable. You could be irritated because this may not be the first time you were hit up. You can understand why I call this “the uncomfortable money dance.” We know the steps, but each partner is stumbling over their own feet.
The other result of this is that usually these loans are not documented. Verbal agreements can be sketchy, crushing both parties’ expectations, and lots of phrases can fly, such as “Don’t worry, I trust you,” or, “I promise I need the money for only a month.”
Looking for expert tips to grow and preserve your wealth? Sign up for Building Wealth, our free, twice-weekly newsletter.
When a legal agreement doesn’t exist, often the lenders have to resort to discussing a formal agreement later on. And we all know that without written documentation, it’s hard to resolve misunderstandings. In addition to all that, some lenders may lend money they can’t afford to lose.
According to the FinanceBuzz survey, more than a quarter of lenders (26%) had to set up a formal payment plan to get their money back, while 25% reported that lending money led to awkward family interactions and hurt feelings.
How to avoid family loans that lead to family feuds
Set expectations. If you are strapped but want to help, explain that to the borrower. Be clear about when you want the money back, plus all of the repayment terms, such as:
- Will there be an interest charge?
- When and how will payments be made?
- You may also negotiate “gifts in kind.” For example, the borrower could help you with work around your house in lieu of payment.
If you feel more comfortable with giving the money as a gift, with no strings attached, you should make that clear. You don’t want to open the door for them to keep coming back for more.
Don’t enable poor financial habits. Is this situational, or is it habitual? If it’s the latter, it’s time to sit down with the borrower to help them design a workable budget, or recommend going to a financial counselor so that borrowing is not a constant habit.
You might also want to make sure that you are not supporting bad habits such as gambling, drug use or living beyond one’s means.
Put it in writing. Yes, this one could be awkward, but you can explain that your relationship is important and you don’t want any misunderstandings. You can download really simple promissory notes online, or you can access a free loan agreement at LawDepot.com.
A written agreement should outline the loan terms, repayment schedule and any interest, even if it's a small amount. This will make it real for both parties.
Borrowing from friends and family can be a helpful solution in times of need, but it's essential to approach such arrangements with caution and clear communication to preserve relationships and financial well-being.
There is an American proverb that I love: “Before borrowing money from a friend, decide which you need more.”
Related Content
- Intrafamily Loans Can Be a Smart Move to Boost Wealth
- Smart Ways to Give (or Lend) Money to Family
- Gifts vs. Loans: Don’t Be Generous to a Fault
- The Bank of Mom and Pop: The Benefits Afforded by Intrafamily Lending
- How to Teach Your Kids About the Tax Facts of Life
-
5 Types of Gifts the IRS Won’t Tax: Even If They’re BigGift Tax Several categories of gifts don’t count toward annual gift tax limits. Here's what you need to know.
-
The 'Scrooge' Strategy: How to Turn Your Old Junk Into a Tax DeductionTax Deductions We break down the IRS rules for non-cash charitable contributions. Plus, here's a handy checklist before you donate to charity this year.
-
IRS Says You Made a Tax Return Mistake? A New Law Could Help You Fight BackTax Law Updated taxpayer protections change what the IRS must explain on error notices and how long you have to respond.
-
I'm a Tax Attorney: These Are the Year-End Tax Moves You Can't Afford to MissDon't miss out on this prime time to maximize contributions to your retirement accounts, do Roth conversions and capture investment gains.
-
I'm an Investment Adviser: This Is the Tax Diversification Strategy You Need for Your Retirement IncomeSpreading savings across three "tax buckets" — pretax, Roth and taxable — can help give retirees the flexibility to control when and how much taxes they pay.
-
Dow Rises 497 Points on December Rate Cut: Stock Market TodayThe basic questions for market participants and policymakers remain the same after a widely expected Fed rate cut.
-
The Top 22 Gifts for Grandkids from Walmart in 2025From PlayStation to Labubu, you'll find the hottest gifts of 2025 for your grandkids at Walmart this year. Some of them are up to 78% off.
-
Could an Annuity Be Your Retirement Safety Net? 4 Key ConsiderationsMore people are considering annuities to achieve tax-deferred growth and guaranteed income, but deciding if they are right for you depends on these key factors.
-
I'm a Financial Pro: Older Taxpayers Really Won't Want to Miss Out on This Hefty (Temporary) Tax BreakIf you're age 65 or older, you can claim a "bonus" tax deduction of up to $6,000 through 2028 that can be stacked on top of other deductions.
-
JPMorgan's Drop Drags on the Dow: Stock Market TodaySmall-cap stocks outperformed Tuesday on expectations that the Fed will cut interest rates on Wednesday.
-
CD vs. Money Market: Where to Put Your Year-End Bonus NowFalling interest rates have savers wondering where to park cash. Here's how much $10,000 earns in today's best CDs versus leading money market accounts.
