Should You Lend Money to a Relative?

If there’s any chance of endangering your relationship, don’t engage in family banking, says expert

By Deborah Jeanne Sergeant

 

Family banking seems easier, as it’s simpler to get approval and the interest rates (if any!) are much lower.

But before you receive or hand over cash, consider the facts related to the transaction.

For example, “Does the borrower have the capability of paying back the loan in the timeframe expected or agreed upon?” posed Randy L. Zeigler, certified financial planner and private wealth adviser with Ameriprise. “The lender should think like a banker who is considering extending a loan to the borrower.”

One major factor is that the borrower should not have any existing addictive behaviors such as substance use, alcoholism or problem gambling.

Avoid lending to this family member “no matter what they say or how dire their situation, unless they have demonstrated a lengthy period of sobriety and even then, the risks are always elevated,” Zeigler said.

It also pays to closely scrutinize borrowers’ personal ethics, such as their honesty, decision making skills and appreciation to the lender. A borrower who feels “owed” this opportunity isn’t a safe bet.

“Is there any indication that the borrower will just take advantage and avoid repayment?” Zeigler added.

The borrower and lender should agree on fair and reasonable terms for the loan, such as a day of the month that payments will be made, method of repayment (such as cash, checks or bank transfers), interest charged and the timeline for repayment.

Why does the borrower want the money?

“If it will just support the borrower’s short-term cash flow need, is it likely they will be able to pay back the loan or will they be in the same position in the near future because their monthly expenses exceed their income?” Zeigler asked. “In these cases, the loan is rarely ever paid back so the lender should not extend the loan except in unusual circumstances, though in this case it might make more sense to make a gift to aid the person rather than a loan that is likely to default and then cause hard feelings.”

Sometimes, people want to borrow money with a goal in mind. Zeigler takes a pragmatic approach if borrowers want the money to improve their lives such as for education, occupational training or some employment related purpose. These reasons are associated with a better chance of earning a bigger income and a better chance of repaying the debt.

Lenders should not lend (or give) money that they need to cover their own expenses or that tap their retirement or emergency funds.

“Lenders should never borrow money themselves or co-sign a loan in order to make a loan to a family member who has promised to make the repayments unless the monthly payments are easily handled within the cash flow of the ‘family’ lender,” Zeigler said. “If that is not the case and the ‘family’ borrower is not able to make the repayments for whatever reason, then both family members could end up in financial jeopardy.”

People should only lend what they can afford to lose.

Think carefully before agreeing to borrow or lend among family members. Is the potential for strife worthwhile? If it’s done carefully, families can benefit each other by obtaining lower interest rates than banks charge and the lender receiving a higher rate of return than leaving the money in a savings account.

But if it’s not done well, Zeigler warned that these transactions can result in “disappointment, resentment, anger, bitterness, hurt and loss of family cohesion,” he said. “Making family loans can be like walking through a field of landmines. It has been done successfully by a few people, but it’s fraught with challenges and both financial and emotional risks.”

If there’s any chance of endangering your relationship, don’t engage in family banking. Financial matters are very personal.

“Even the topic of money tends to activate complicated feelings,” said Erica Randall Lacey, Ph.D., a licensed clinical social worker who teaches clinical mental health counseling at Le Moyne College. “The borrower may feel embarrassment, shame or guilt for asking. The lender may feel pressure to help out of care or obligation, even if they are not in a position to do so. Those feelings alone can shift how relatives see each other.”

She views family banking as a means of possibly shifting relationship dynamics or reactivate former roles such as the “responsible one” or “the irresponsible one or “the rescuer.” The expectations can carry over to other areas of life.

Planning the arrangement makes a big difference. Lacey said that oftentimes, informal lending among family members leads to misunderstanding.

Unlike borrowing from a bank, in family lending, “a lender may feel entitled to monitor or judge the borrower’s choices,” Lacey said.

The lender may judge how the borrower spends money such as taking a vacation instead of paying more money on the loan.

“If payments are late or never come, the emotional impact can be much larger than the financial one,” Lacey added. “The lender may feel resentful or taken advantage of. The borrower may feel ashamed or avoidant, pulling back from family gatherings or contact.”