Image: Man meeting with financial adviser in living room © Chris Ryan, OJO Images, Getty Images

There's nothing wrong with wanting to help a loved one in a financial bind, but not if it will derail your own finances.

Lending money to family and friends can also ruin relationships. Lenders and borrowers often have a different recollection of a personal loan's terms, and unpaid loans can lead to lingering bad feelings between the lender and borrower, according to a study published in the Journal of Economic Psychology in June 2012.

Still, many consumers have a hard time denying requests for financial help from family and friends. In fact, a July 2012 study in Britain found that children as young as 8 are breaking the piggy bank to lend money to their parents.

One of the biggest mistakes people make is they say yes without thinking it through, says Kathy Virgallito, a regional director of partnerships for Apprisen, a credit-counseling agency based in Columbus, Ohio. Many also say yes when they want to say no because they are afraid they will be considered selfish or they'll lose the relationship, says Maggie Baker, the author of the book "Crazy About Money: How Emotions Confuse Our Money Choices and What to Do About It."

Fear, however, should not determine whether you lend money, experts say. And if you say yes when you want to say no, you may feel resentment toward the borrower over time, particularly if the person doesn't repay the loan, says Linda Stiles, a Kansas-based licensed clinical social worker specializing in financial matters.

Making your decision

Before lending money, determine whether you can afford it, says Virgallito. Consider what other uses you had planned for that money. "If it's in an account that you weren't going to touch for a while, it may not impact you," Virgallito says. But if it's in your emergency savings account or a 401k account where you'll be penalized for the withdrawal, lending the money could put your own finances in jeopardy. Borrowing the money to lend to someone is also a bad move since it could lower your credit score and leave you paying interest on somebody else's debt.

Jaime Catmull of El Segundo, Calif., worries not so much about whether a family member or friend can pay her back as she does about her own financial situation. "I follow one rule," she says. "Lend it thinking you may never get it back."

Another thing to consider before lending money is why the person needs it. Has something occurred out of the person's control, such as a job loss or an unexpected medical bill? Or is the person simply financially irresponsible?

"Even if somebody is only asking you for $20, if they're asking you every other week, that can be a red flag," says Virgallito. Helping a financially reckless family member may in fact be hurting the person in the long run, as it is enabling a negative behavior, says Stiles. "Maybe bailing them out will teach them that they can keep spending their money on things that are not priorities," she notes.

If you do decide to lend the money, put the agreement in writing, outlining how much the loan will be, when it will be paid back and if there is any interest on the loan. Brenda Della Casa of New York once borrowed money from a friend, and "we agreed to a payment amount and schedule, and I honored that," she says. "We also agreed not to discuss the money at all . . . and it worked out brilliantly."

But if it's in your best interest, whether financially or emotionally, to say no, consider the following tips:

  • Express empathy. Let loved ones in this situation know that you understand they are going through a tough time and you believe they will be able to pull through it, says Stiles. You can also offer other ways of support, such as a willingness to listen or an invitation for dinner to mull over other ways to handle the financial challenge, she adds. Also, stay engaged with such people throughout their financial troubles by asking them periodically how their situation is going and letting them know you're still emotionally supportive, Baker adds.
  • Reference your financial obligations. People who need financial help may point to all of the reasons why you have the money to spare. Let them know that even if you do have the money, you already have plans for it, says Virgallito.
  • Offer advice. Depending on how close you are to this person, this could be a teachable moment that allows you to give someone insight into better financial management, Baker says. For example, a grown child who has an unexpected health bill might benefit from a conversation about the importance of paying for health insurance or the benefits of creating an emergency fund.
  • Direct them toward resources. If people asking for money have shown irresponsible financial behavior in the past, suggest places where they can go to get a better handle on their finances, such as a credit-counseling organization, a financial literacy class or even a personal finance workshop at a church, suggests Virgallito.
  • Expect to feel guilt. It's normal to feel guilt or stress for not being able to bail out your loved one. Anticipate this, and, if necessary, go to someone whom you trust to talk about your feelings as you move through the process, Stiles suggests.

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