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The Good and Bad of Loaning Money to Friends and Family

For many people who have a little extra cash to spare it’s not a big deal to pay for a friend’s meal or hand over a few hundred bucks to a family member who’s down on their luck; but there are a number of factors to consider when you hand over a monetary favor.

Nearly 60% of people who lend money to family and friends have “something bad happen”. Either the terms of repayment aren’t met, or that person has ghosted the lender. Worse, some people will see your donation and start thinking they have found a “cash cow” and continually ask or even demand more from you. Every time you lend money to someone you are introducing a new power dynamic to the relationship… and frequently that dynamic will end up destroying more than the relationship.

A recent survey run by CreditCards.com revealed that 59% of people who lend money or paid for a group expense ended up burned by the experience. 42% never got their money back and 26% said their relationship was damaged as a result.

Financial educator Jennifer Moorhouse said, “When you loan or borrow money from a friend or family member it automatically adds an extra layer of complexity to that relationship.”

Consider the following before you lend

If you are going to lend someone money there are a few things to keep in mind.

Will lending money create a strain on your own finances if the money isn’t repaid in a timely manner? Are you ok with never having the money repaid?

There is more than a 50/50 chance that the person you are loaning money to will either pay late or never repay the loan at all. Can your current financial situation handle that possibility? Only loan money that you are ok loosing.

Will the loan put a strain on your relationship?

Many people are happy to be in a position to help out a relative or friend, but remember that loan changes the dynamic of the relationship even if you remain on friendly terms

Will you be ok with how they decide to use the money?

Frequently people that ‘run out of money’ do so because they are terrible at managing a budget. Maybe they spent their own money on a trip or extravagant purchase and now can’t pay their rent or car payment and that is where your money is really going… to finance their folly. Other people may beg for assistance under false pretense only to use it for something else. You need to be ok with however they choose to use ‘your money’.

Will giving them money only be a Band-Aid for a larger financial or personal problem that person may be facing?

“If you see someone asking for financial help, but they need help that goes beyond that such as health issues, addiction, severe debt, bankruptcy, etc. offering money may not actually be what they need and will most likely make things worse or prolong the real problem” says Moorehouse.

For instance, rather than helping your parents pay their rent, why not take a look at their current budget and find ways for them to cut costs so they can afford to pay their own. One or two payments won’t wipe out a lifetime of poor money management skills.

Tax and legal implications

If you have asked yourself the above questions and you still feel that offering financial help will be fine, the next step is to make sure that you have an understanding of any lurking hidden costs.

Depending on the size of your loan and if you decide to charge interest, you may need to claim the interest as income on your next tax return. If it is a larger amount of money it could also end up falling into the governments ‘gift’ category which can also have tax implications. “It’s important to talk to a tax professional or financial planner before lending large amounts of money,” says Moorehouse.

The general rule is that any monetary or high value (such as real estate) gift is a taxable gift. However, there are many exceptions to this rule. The gift tax ranges from 18% to 40%, depending on the size of the gift. Annual caps apply. In 2022 the maximum cap is $16,000. It’s always good to speak with a tax advisor in addition to a financial planner if you are going to be offering a large sum of money.

So what can you do?

To avoid any future trouble with your loan whether it ends up repaid or not, it’s important to look at formalizing a promissory note or contract with the other person. It may be advisible to involve a financial advisor and even a notary public to witness the contract.

Even with a contract there are no guarantees of repayment, so many people who lend money offer it as a gift with no strings attached. If it’s repaid at a later date more’s the better. This can ease any tension that may arise from the situation.

It’s also a good idea to look at your personal boundaries about lending money to others. It feels good when you can help other people and be generous in situations that call for it, but spending more than you have available in your budget is never healthy.

It’s also important to note that while most people will be grateful for a one-time loan to help them out of a tight spot, others will start to expect you to become their personal bank and financier. You should never feel obligated to hand your hard-earned money over to anyone. If this has been a problem for you in the past you should work on building healthy boundaries around money.