Lending money to family and friends can be a gesture of goodwill when someone you know is in a tight spot financially, but it can be problematic if your efforts to help lead to disagreements or you experience financial issues as a result.
According to a 2022 survey by Creditcards.com, 42% of respondents surveyed said they had lost money through loans made to friends or family members. If you’re approached by a friend or family member for a loan, keep these do’s and don’ts in mind.
- Lending money to friends and family can lead to financial problems for you and potentially cause relationship damage.
- Creating boundaries for loans to friends and family can help preserve relationships and minimize the potential for problems.
- Co-signing a loan for friends and family in lieu of lending them money directly can also be problematic.
- Before lending money to friends and family, consider how it could affect you financially and emotionally.
- Lending money can incur tax implications for both the borrower and the lender.
Friend and Family Loans: When Do They Make Sense?
There are certain situations in which a friend or family member might approach you to borrow money. For example, you might be asked for a loan if they:
- Need money quickly to cover an emergency expense
- Lack sufficient credit history to qualify for a personal loan or line of credit
- Don’t meet the income requirements for a traditional loan due to illness or job loss
While you may feel pressured or obligated to offer a loan, it’s important to consider whether it makes sense for you and your financial situation. For instance, if lending money to someone would put a strain on your own finances and make it difficult to keep up with your bill payments, it’s probably not the best move. On the other hand, if you have a sizable emergency fund, little or no debt, and you’re getting a steady paycheck, making a loan might not be as difficult to manage.
Aside from the financial implications, it’s also important to think about how likely you are to get the money back. If the friend or family member who’s asking for a loan is responsible about paying their bills and experiencing a one-time financial crisis, being paid back might not be an issue.
If, on the other hand, you’re approached by someone with a history of being financially irresponsible, you could be taking a bigger risk by lending them money.
Review your budget and savings to see how much money you’re comfortable committing to a loan.
The Do’s for Lending to Friends and Family
Lend Money Only to People You Trust
If you’re lending money with the expectation that you’ll get it back, then it’s important to be selective about to whom you offer a loan. Limiting loans to friends or family members you trust to pay back what they owe can help you avoid financial and emotional headaches later. In the Lending Tree survey, for example, more than a third of borrowers and lenders reported negative consequences, including resentment and hurt feelings.
If you don’t feel comfortable lending money to someone, then it’s OK to say so. You may get some pushback, but it’s important that you’re only lending money when you’re confident that it won’t cause the relationship to go south.
Consider asking the person to whom you’re lending money for some type of collateral equivalent to the loan amount that you can hold as security until the loan is repaid.
Limit Loans to What You Can Afford
Making a large loan to help someone out is a bad idea if it puts the squeeze on your own finances. When deciding how much to lend to someone, a good way to frame it is to think of the money as a gift. In other words, how much money could you lose without it hurting you financially?
This doesn’t mean you should assume you won’t be repaid. Instead, it helps you set some realistic boundaries for lending money to friends and family, that way you don’t end up in the position of needing a loan yourself later.
Get It in Writing
When making a loan to friends or family, having a paper trail can help you avoid misunderstandings. Drawing up a loan contract that you and the borrower agree to and sign makes it clear what your responsibilities are, and it gives you grounds for legal recourse if you end up needing to sue them later to get your money back.
At a minimum, your loan contract should include:
- Your name and the borrower’s name
- The date the loan was granted
- The amount of money being lent
- Minimum monthly payment
- Payment due date
- Interest rate, if you’re charging interest
- Consequences for defaulting on the loan
For larger loan amounts, it may be wise to have an attorney draw up a contract for you. You may also want to talk to a tax professional if you plan to charge interest on the loan.
If you plan to charge interest, it must be at a minimum rate in accordance with Applicable Federal Rates (AFR) rulings. For loans over $10,000, interest is considered taxable income. Even if you don’t charge interest, you may still have to report the money as a gift if it isn’t repaid.
If you choose to gift money to friends and family versus lending it, you can give up to $16,000 per person annually in 2022 (increased to $17,000 for 2023) without triggering the gift tax.
The Don’ts for Lending to Friends and Family
Don’t Lend More Than You Can Afford
This should be obvious, but it’s worth repeating. Lending more money than you can realistically afford can only lead to problems if the person to whom you lent the money doesn’t repay it punctually or you have a harder time keeping up with your expenses as a result.
Don’t Let Guilt to Drive Your Decision-Making Process
It’s also important that you don’t allow guilt or other pressures to force you to lend money to someone you know. If you feel obliged to lend money to someone when it doesn’t make sense for you financially, it’s worth taking a step back to consider other ways in which you might be able to help them. For example, you may be able to point them in the direction of other resources that could offer financial relief, apart from a loan.
Co-signing makes both of you legally responsible for the debt. If the other person defaults on payments, the creditor could come after you for payment.
Don’t Lend Someone Your Credit
You could offer to co-sign a personal loan for a friend or family member in place of lending them money yourself—or you might let them use your credit card in a pinch. This way you’re not handing over any money out of pocket.
Co-signing a loan, however, can affect your credit score, as the inquiry, payment history, and loan balance will show up on your credit report. And if someone else is using your credit card to make purchases, you’re directly responsible for any balances they rack up. These are options you may only want to consider as a last resort alternative to making a loan directly.
Can I Legally Lend Money to a Friend and Charge Interest?
You can lend money at interest, provided that the interest rate falls within the appropriate legal guidelines. Most states have usury laws that limit the maximum amount of interest that a lender can charge. In addition, you should also consider the Applicable Funds Rate prescribed by the Internal Revenue Service (IRS). Interest rates lower than this amount may be considered a gift and can incur a taxable event.
Is Lending Money to Family Taxable?
Intrafamily loans can be taxable, for both the borrower and the lender. If the value of the loan is greater than $10,000, any interest payments may be considered taxable income. In addition, if the lender forgives part of the loan balance or accepts a below-market interest rate, this may be considered a gift to the borrower, incurring a gift tax.
Why Should You Never Lend Money to Friends or Family?
Lending money can damage relationships with your friend and family, especially if they might have trouble paying it back. This emotional damage can often feel worse than losing the money. It’s wise to avoid mixing money with family–but if you still feel compelled to lend them money, be prepared for the possibility that you won’t get it back.
The Bottom Line
It’s a fine line between helping out a love one who may be struggling and jeopardizing your relationship. On one hand, you might have funds on hand to help a family member or friend that needs money. On the other hand, lending money to anyone—especially someone who is financially struggling—puts your own finances at risk. When contemplating the best course of action, consider the reasons above to decide whether or not to loan money to people in your network.