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How to lend to family and friends

These 3 real-life stories illustrate the potential benefits and pitfalls of making a loan to people who are close to you.

By MSN Money Partner Jun 15, 2012 10:14AM

This post comes from Len Penzo at partner blog Len Penzo dot Com.


Len Penzo dot Com on MSN MoneyMaking a loan is always a dicey proposition. After all, once you lend the money, there's no guarantee it will be repaid.


Image: Man taking money out of wallet (© Jose Luis Pelaez Inc/Blend Images/Getty Images)The stakes are even higher when we lend money to our friends and family -- or even co-sign a loan -- because we not only risk our hard-earned money, but we also endanger important personal relationships. Many people refuse to lend money to friends or family for precisely that reason.


I've lent money to friends or relatives on only a few occasions, and I am happy to say I've never been burned -- but there are certainly lots of people who have. (Post continues below.)


Here are three true stories I want to share with you about loaning money to friends and relatives.


True Loan Story No. 1

Shortly after the Honeybee and I were married, she got a phone call from a girlfriend who was in a bit of a financial jam. Her car was in the shop, she was completely broke, and she needed $200 to cover the bill. And without the car, she had no way of getting to work.


Making the situation more dire was the fact that the friend was a single mom with a couple of young kids.


When I came home from work, the Honeybee explained the situation. Of course, being the heartless guy that I am, the first question out of my mouth was: Why doesn't she have an emergency fund? I know.


And to be honest, I resented being put on the spot.


At the time, the Honeybee and I were just starting out -- and we were sacrificing. We were eating lots of macaroni and cheese and rice and beans to ensure we spent less than we earned. Matthew was still a baby, and by the time we were finished paying the mortgage for our new home, the car loan, and all our other bills and obligations that come with being financially responsible -- like saving for retirement -- there was very little money left for discretionary spending.


In fact, back then our entertainment budget was a paltry $25 per week, so I hope you can understand how I felt when we were being asked to loan a friend $200.


Anyway, after a lot of thought, we raided the money from our savings to make the loan.


Two months later, we got our money back.


True Loan Story No. 2

After 10 years of battling the elements, the wooden privacy fence surrounding our property was on its last legs. I insisted on replacing it with a block wall, but one neighbor balked at the idea because he didn't have the $2,000 required to replace his half of our wooden fence with the better-quality block variety.


So, to break the stalemate, I offered a $2,000 interest-free loan and asked that he pay me $100 per month until the loan was retired.


My neighbor agreed and I drew up a payment schedule that he signed. I then paid the contractor to build the block wall.


I'm happy to say my neighbor never missed a single payment and the loan was paid off on time.


True Loan Story No. 3

An out-of-town relative of mine who was struggling a bit financially -- let's call him Mike -- made it known to the family that he was looking to buy a truck for his business.


One day, Mike's mom found an unbelievably great deal on a truck and told Mike about it. Unfortunately, Mike said he couldn't scrape up the $18,000 that the truck's owner wanted.


So the mother and son came to an agreement: She would buy the truck -- with some inheritance cash she had just received -- and her son would then pay her back over several years. After Mike agreed to a monthly payment plan, his mom bought the truck and gave him the keys.


Three months later, Mike stopped making the promised payments.


Incredibly, somewhere along the line he also managed to dupe the Department of Motor Vehicles into getting the pink slip transferred over to his name.


A couple years later, Mike sold the truck. Even so, his mother never received another penny.


Is she bitter? You bet.


The smart way

When friends or family say they're in a financial bind and need a loan, our natural inclination is to help, but that doesn't mean we always should.


I always ask myself two very important questions before loaning money to friends and family:

  • Can I afford to make the loan?
  • Am I willing to let bygones be bygones if I don't get all the money back?

As I see it, when I can't honestly answer "yes" to both of those questions, I have no business loaning the cash out in the first place. But when I can, I'll take the plunge.

That way, if I do happen to get the money back, then I'm rewarded with an unexpected bonus. And if I don't get the money back, well, it's c'est la vie -- although I promise it would be the last penny they'd ever see from me.


Fool me once, shame on you. Fool me twice . . . well, that ain't gonna happen.


I'm curious. What about you? Are you willing to loan money to a friend or relative? Have you ever been burned after loaning money to friends or family members? If so, how did it affect your relationship?


More on Len Penzo dot Com and MSN Money:

6Comments
Jun 15, 2012 3:11PM
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Yes, I did. And yes, I lost a friend. We shared an apartment. We both worked retail, for minimum wage. I had a savings account. She didn't. She used her money to fly cross country to visit her parents. She just needed a small loan to cover the current month's rent. I lent it to her. Then she announced she was leaving to move home and I would have the apartment all to myself. That wasn't a completely bad thing - the apartment was small, and I could afford it by myself. But after she'd been home three months and still hadn't repaid me, I started sending angry letters. She was really miffed. Got the money from her parents, and never spoke to me again. No good deed goes unpunished.
Jun 16, 2012 10:32PM
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Be prepared to be generous and forgiving if you choose to provide personal loans +1
Jun 15, 2012 4:24PM
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My immediate family and I lend and borrow all the time, but we always, always repay.  When there's no stress for paying it back timely we communicate that.  When the loan needs to be repaid timely due to other obligations, that is communicated even more clearly.  We have built up 'good credit' with each other and trust that the repayment will be made as agreed.

However, I lent a friend a relatively large sum of money to be paid back in a month and a half's time.  This friend explained how they planned to get the money to repay me.  I even took time to communicate that it was not 'extra' money and not getting it back would cause me some hardship, hoping that would ensure my friend would do their best to repay me.  Weeks after the loan should have been repaid, the friend started making promises to give me something on it "in a few weeks" or "with their next check."  This went off and on for over a year without me receiving a dime and I eventually forgave the loan hoping to salvage our friendship.  The continued broken promises was making me resent and lose respect for this person; more so than not getting repaid.

In the end, our friendship is still in tact because I, too, thought through your two rules: Can I afford it and Can I forgive the loan?  I won't lend this person money again no matter how dire the need, my faith in the friendship is a little diminished, and the ability to answer yes to the second question the next time a friend asks for a loan will be a little tougher.

Jun 17, 2012 11:43AM
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I have loaned money to both friends & relatives.  Of the friends, I got 100% back, some even with interest.  Of family, it has been less than 50/50...  But my philosophy is that it is only money & if I have it to give, well--why not "give at home" instead to some charity or concern where I am not sure how much of it or even any of it is going where I intended.  As for why I don't outright give it away when I can?  I don't think that it is a good idea to let anyone , including my kids, think that things come for free.  It creates unrealistic expectations.  And, if I loan anything & never get it back, I never loan that individual anything again.  But in the case of family, I would do the same for friends in the same situation, if I really see that they are in a bind again, I try to find a way to help out  in a way that doesn't require them asking.
Jun 15, 2012 3:50PM
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Be prepared to be generous and forgiving if you choose to provide personal loans
Jun 19, 2012 6:55AM
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I treat my retirement funds as bills that have to be paid.  I am honest when asked for money that I have no extra money except emergency fund which is for our emergencies only! I live more simply than anyone I know....duct tape hole in shoes and pb&j's for lunch. I almost laugh when someone who drives a bmw or wears name brand clothes asks for a loan and says they will pay what they can each month.............don't be fooled.......  Be stong savers!!!!!!!!
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