How to lend to family and friends

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

Making a loan is always a dicey proposition. After all, once you lend the money, there's no guarantee it will be repaid.

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.

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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:

• 9 important money tips every dad should teach his kids
• Why you should (and shouldn't) pay your mortgage early
• 10 key characteristics of debt-free people (of modest means)
• Co-signing a loan? Uh-oh
• How much car can you afford?
• It's easier to get a car loan now