| May 28, 2013

Set ground rules when lending money to family members

“For most people, maintaining and belonging to a close-knit family is everything and there is very little a person wouldn’t do to help out a relative in need. For this reason, family is often the first place individuals turn when they are experiencing financial difficulties, such as mortgage problems, credit card debt or an inability to make ends meet. In other cases, members may also request funding for a business venture or investment opportunity. While many people who are in a position to lend money to family members may be happy to help, it’s not uncommon for money disputes to lead to tension and discord.

There are several scenarios in which lending money to relatives may not be the optimal choice. For example, if debt is a recurring problem for a relative who has been bailed out by loved ones several times and failed to change their spending habits, consumers may be loathe to continuously put their own financial safety on the line. In other cases, members may want to help a loved one out of a tight spot that resulted from circumstances beyond their control – such as a job loss or illness – but would be forced to drain retirement accounts or otherwise endanger their finances by doing so.

In order to make the best possible decision, it’s important for a person to take a hard look at why family members are requesting a loan and determine if they agree with the reason. It’s also crucial for prospective lenders to consider whether extending the amount will be too impactful to their own security. A recent Forbes article highlighted the retirement risk many boomers are facing if they lend money to children or other relatives who fail to pay them back.

Setting guidelines may lead to responsible lending

One way that individuals can better protect themselves should they decide to extend a loan is to treat the transaction formally by setting up a contract. A standard contract can help mitigate disputes about the loan amount, repayment schedules, deadlines and how the funds should be used.

While no individual wants to think about having to take legal recourse to recoup the amount they gave to a family member, a contract will give them more legitimacy in court if they are forced into the situation. Many borrowers also feel more comfortable with a contract in place because it may help separate a business relationship from a family relationship, and these boundaries may help families stay close and intact when there is a money involved. 

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