How to Successfully Loan Money to Family and Friends
Over the holidays, I saw the movie Sisters, starring Tina Fey and Amy Poehler. In it, they each play a stereotypical character: Poehler is Maura Ellis, the “perfect” sister, and Fey is Kate Ellis, the “other” sister (READ: irresponsible). Kate is flat broke, and inevitably asks both her sister and her parents for a loan… but of course she only wants the kind you never have to pay back.
I mean, would you loan money to this person — even if she were your sister?
And this is EXACTLY why loaning money to family and close friends is generally seen as a horrible idea. There are certainly many reasons not to (and you can read about my top 4 reasons here), but turning down your nearest and dearest is not always that simple.
After some personal experience and also professional analysis, I believe that it is possible to successfully loan money to family and close friends if you approach it as clearly and carefully as any other business transaction. While you won’t be able to eradicate all of the risk, you’ll at least mitigate it if you follow these following rules:
1) Before you do anything, put on your business cap.
In any business dealings with family, you have to switch “hats” from casual and personal to formal and professional. And a loan is most definitely a business transaction, so it’s on you to send the right message from the start. That way down the line if repayment milestones are missed, you can easily say, “I’m going to switch hats right now, and I’m going to talk to you about the loan and the terms per the contract, period.”
2) Clearly communicate the parameters of the deal – IN WRITING — so it’s a contractual agreement, otherwise known as a promissory note.
Once you’ve made sure that the tone of the transaction is clearly professional, then you are then in position to explain the nature of the deal to the party borrowing money. Make sure to include all of this crucial information in your agreement:
- Name of borrower/lender
- Amount of the loan
- Length of time of the loan/maturity date
- Repayment schedule (if not all at once)
- Interest rates (if applicable)
- Responsibilities of each party, especially how repayment will be provided
- Security for the loan (if possible)
- Penalty (if any) for missed repayment deadline(s)
The way you put a loan in writing is through a promissory note, which can be a very simple document. At a minimum, it will detail all of the above, plus date/time/place of signing. If the loan is large enough, then explaining the security for the loan is key. This gives you a tangible way, such as a lien against his/her house, to recoup your payment should the borrower default on the loan.
For example, if your sister wants to borrow $150,000.00, she needs to give you a lien against her house so that you can self execute if necessary. And while you may not want to go to that extreme length, having your position secured against real property may at the very least give you significant leverage to get her to repay the loan.
3) Trust is NOT a part of the equation…
Very often people involved in a family or friend-related loan transaction will feel that they can’t document the deal because it will convey the message to the borrowing party that they don’t trust him/her. Here me now: TRUST has nothing to do with the official end of any BUSINESS transaction, ever! In my opinion, it is a common yet HUGE mistake to concern yourself about what your family member or friend will think. Take the emotions and opinions out of the equation, and you’re left with a much cleaner perspective – which should go a long way in terms of reinforcing the idea that loaning someone money isn’t personal. It’s business.
4) … Risk, however, is.
If your friend or family member could get a bank to loan him or her money, s/he wouldn’t be coming to you – right? Be clear that there is inherent risk in your executing this type of loan, especially if you think about whether or not a bank would consider the person asking you to lend him/her money a safe bet. In most cases, it’s unlikely that a financial institution would approve the transaction, and for that reason alone, you have every right to act as prudently as possible to protect your own interests. That’s not about being a bad friend or relative – it’s about being a smart businessperson.
5) Be sure you set the expectation of enforcement.
While a promissory note goes a long way in terms of reinforcing the idea that this isn’t personal, it’s business, you also have to communicate to your family member or friend that you’re willing and able to enforce the terms if s/he breaches your agreement. If you don’t do that, then you’re going to be in a situation where the borrower thinks that s/he has the friendliest lender in the world, and say to him/herself “It’s my relative (or close friend), so it’s OK if I never pay him/her back. By the way, s/he’s got enough money and really doesn’t need me to do it.” Keep in mind it’s nobody’s business what you have to lend, and a loan is a loan.
6) Have an enforcer standing by.
Be it a lawyer or another type of business advisor, bringing a third party in from the get-go to be involved with the creation and execution of your agreement is key. That way should a dispute arise, you’ll have an unaffiliated, neutral person available to bridge the gap between you (the lender) and your family member or friend (the borrower). Any guilt, awkwardness or other uncomfortable feelings will be minimized and enforcing the terms of agreement will be much easier and far less painful.
While loaning money to a family member or a close friend might seem complicated, it’s no more so than any other business transaction. And that, after all is the key differential: while you can share with your sister (or brother) a bedroom, clothes, even party prep and ask for nothing in return, when it comes to your hard-earned cash, a loan is something that always should be repaid.
Photo: Pictures of money