Should you ever loan money to family and friends? It’s a tough question. Some of you might say, “sure, why not?” And others might think, “Maybe just to family.”
Well, if you do decide to loan money, I’d recommend asking yourself this question: Do I have to borrow money to do it?
If you do have to borrow to help, you shouldn’t loan money… even if it’s to family and even if they say they’ll pay you back. Now I realize that sounds harsh, but it’s in your best interest to not get yourself into financial trouble.
Take it from Mary. That’s not her real name. But I remember her situation very well. Mary was widowed and retired with no debt and some money in the bank. Her money troubles began when her son was going through a divorce and needed money to pay for a lawyer and a new place to live. It wasn’t her first time helping him out with money. Before she retired, she had helped him through a job loss, but back then she was working, so she could afford it. This time was different. She didn’t have the money, so she had to do something she’s never done before – borrow.
Her son promised that he would pay her back once he was back on his feet…
Even two years after loaning him the money, her son was still struggling and unable to pay her back. That left Mary to make the payments on the loan by herself on her line of credit each month. Eventually, she maxed out her line of credit. She also couldn’t borrow more money, so she started to fall behind on her payments. That’s when she came to see me.
Sadly, situations like these are all too common.
The moral of Mary’s story isn’t that you shouldn’t help, but you shouldn’t loan money you can’t afford and never borrow to loan someone money.
Ask yourself these three questions when faced with this dilemma:
- Can I afford it? In other words, can you afford the loss if they don’t pay the money back.
- Will it help? Sometimes giving someone money or co-signing a loan isn’t the best solution for them financially. I see this often when parents help someone buy a car or house they can’t afford.
- If you decide to help, despite the first two questions, how can you protect yourself. Consider registering a mortgage against their home or taking our some form of security to protect what really is your investment.
Listen to the podcast to hear more about Mary’s story and why you should never loan money to family and friends.
FULL TRANSCRIPT – Show #171 Never Loan Money to Family and Friends
Over the years I have met with probably hundreds of people who got into financial trouble by helping others. This seems to be a particularly prevalent problem during the holiday season.
I remember vividly one person in particular. I’ll call her Mary, but that’s not her real name. She was retired, in her late sixties. She had worked her entire life, never made a lot of money, but she was able to pay her bills, and save a small amount, so when she retired she had no debt, and a few dollars in the bank.
She lived a simple life, lived in a small apartment that she rented. She didn’t have a car, but she lived in town and was able to walk everywhere she needed to go. She had a small pension, but because her living expenses were also low, she was able to pay her monthly living expenses with no worries.
Her husband died many years ago. She has two adult children, and three grandchildren.
A few years ago her son lost his job, and she helped him out for a while by covering his rent until he got back on his feet. She was able to help out because she was still working.
Then her son went through a separation and then a divorce, and he needed money to pay for a lawyer, and to find a new place to live. Once again, Mary helped him out, but by then she was retired, so she didn’t have as much money coming in each month, so to help out her son she did something she had never done before: she borrowed money.
She had always had a credit card, which she paid off in full every month, so she had a good credit score, so it wasn’t hard for her to qualify for a line of credit at the bank. Her son promised that he would pay her back once he was back on his feet, but even two years after Mary loaned him the money he’s still struggling, so he wasn’t able to pay her back. That left Mary making the payments, by herself, on her line of credit each month.
Unfortunately on her pension, Mary couldn’t afford the full payment each month, so each month she had to take a cash advance on her line of credit just to make her minimum payments. It was a vicious cycle, and she got deeper and deeper into debt.
Eventually Mary reached the limit on her line of credit. She was maxed out. She couldn’t borrow any more, so she started to fall behind on her payments. She started getting phone calls from the bank, and it caused her a lot of stress.
Mary’s line of credit was at the same bank where she had her bank account, so when she stopped making her regular payment on the line of credit, the bank went into her bank account and automatically debited her account to get the payment. Now Mary was really panicking, because she didn’t have the money to pay her rent.
That’s when she came in to see me.
We had a long chat.
She felt guilty for getting into debt, and embarrassed. I told her that she was a good person. She didn’t get into debt through crazy spending on luxuries. Her debt was caused by helping her son, which is what a good mother would do.
I told her that she can’t change the past, so we need to focus on the future.
My first piece of advice for her was to immediately open a new bank account, at a new bank, where she doesn’t owe any money. Her most urgent problem is that the bank’s computer is automatically taking her line of credit payment out of her bank account, and she can’t stop it, which means she can’t pay her rent. By opening a new bank account at a new bank, and having her pension deposited into that new account, she will be in control of her money.
Next, I suggested that she call her landlord and explain what had happened, so that she could make a plan to get back on track with her rent. She had the money to pay most of her rent this month, and with a new bank account to prevent the old bank from automatically taking her line of credit payment she should be able to get caught upon her rent next month.
That brought us to the biggest issue: what should she do about the money she owed on the line of credit?
I explained her options.
She could file a bankruptcy, which would eliminate the line of credit.
She could also do nothing. The bank would keep phoning her, and they may even threaten to take her to court and sue her, but since her only income is from pensions, and pensions cannot be garnisheed, and since she would be opening a new bank account at a new bank, there would be no obvious way for the bank to get any money from her.
She decided to open the new bank account, and then talk to her son to see if he has any way to at least give her some money to keep making her minimum payments.
Sadly, this story is all too common. Mary’s mistake wasn’t helping her son. It was borrowing money to help her son. She gave him a temporary fix, but she created a very serious permanent problem for herself, and that was very stressful.
That’s why my advice is to never loan money to family and friends.
Why? Because a loan is something you expect to get paid back, so you are likely to loan more than you can afford, with the expectation that you will eventually get your money back.
That’s what happened to Mary.
She wasn’t worried about getting a line of credit to help her son, because she was confident that he would pay her back.
Obviously, so far, he hasn’t paid her back, so now she is stuck with the debt.
So what would have happened if I could have talked to Mary two years ago, and convinced her not to loan money to her son? I assume her son would have had to find another source of money, but most importantly Mary would not find herself in debt and worried about paying her rent.
Now my advice to not loan money to help your family and friends may sound heartless and uncaring. Isn’t that what family is for? To help each other in times of need?
Let me be clear: I didn’t say you shouldn’t help your family. What I said was you should not loan money to family and friends, particularly if you, like Mary, have to borrow money to do it.
Ask yourself this question: If I loan money to a family member, and they don’t pay me back, what happens?
My guess is that, first of all, your relationship with that person will be very strained, and perhaps irreparably damaged. Christmas dinner won’t be very pleasant if you know that the person sitting across the table from you owes you a bunch of money that they promised to pay back, but they haven’t.
I’ve met with lots of people who have lost good friends because of unpaid debts between them.
And again, if you had to borrow money yourself to loan it to a friend, and your friend doesn’t pay you back, not only have you lost a friend, but you have also put yourself in a very dangerous financial position.
So what are you supposed to do if a friend or family member asks you for help?
If you want to help someone, that’s fine, but don’t give them money you don’t have.
My advice is this: if someone needs $20 for a taxi ride, and you’ve got $20 in your wallet, fine, give them the $20 if you want to help out.
Don’t loan it to them; give it to them.
Because it’s a gift, there is no expectation that they will pay you back, so if they don’t pay you back, no worries, you weren’t expecting the money back anyway.
That’s psychologically a lot different than a loan. You expect a loan to be repaid, and if it isn’t, you are upset with your friend, but you don’t expect a gift to be repaid, so if they don’t pay you back, no problem.
Okay, that’s a $20 example, but what about someone who wants a $1,000 loan to fix their car?
Again, if you have $1,000 sitting around that you don’t need, and you want to help them out, fine, give it to them.
But if $1,000 is a lot of money, and you would have to take a cash advance on your credit card to raise the money, the best answer is to tell them “sorry, but I don’t have $1,000. I can give you $100, but that’s all I’ve got”.
That may sound harsh, but it’s the truth, and it will save you a lot of grief in the future.
But wait, you say! I have money, and I want to help my son or daughter buy a house; why can’t I loan them money to buy a house?
You can, but again, how much financial trouble will you be in if they don’t pay you back?
It’s all well and good if you loan them the money for a down payment, and the house goes way up in value, and they are able to refinance and give you your money back, but that’s not always the way it happens.
I can tell you lots of stories where the son or daughter ended up getting separated, and the house got sold, and the parents never saw their money again.
So if, despite my advice, you really want to help your adult children with the down payment to buy a house, I would strongly recommend that you register your loan as a second mortgage on the house, so that if the house is sold before you are repaid at least you are a secured creditor, so you have a chance of getting your money back.
Of course it’s not as simple as I describe it, because the mortgage lender will want to know where the money for the down payment came from, so you can’t register your second mortgage until after the deal closes, so you will be unsecured for a period of time.
Which is another reason why, again, I think it is easier and simpler not to loan people money.
I address this issue in Chapter 21 of my book Straight Talk on Your Money, and I conclude that chapter with this advice:
Ask yourself three questions before you loan money to family or friends:
Question #1: Can I afford to help? If you have to borrow money to help, you can’t afford it, so just say no.
Question #2: Will helping help? Giving your child the money for a 5% down payment on a house they can’t afford is hurting them, not helping them. You are setting them up for a future financial disaster, so it is probably in their best interests to keep saving money, and buy when they are able to afford it on their own.
Question #3: If, despite my better judgment, I decide to help, how can I protect myself? Registering a second mortgage on a house loan is a basic step you should consider.
Ultimately, whether or not you help is up to you.
I’m actually a big believer in helping out your family and friends, I just prefer to do it by giving money or other help when I can afford it, and not loaning them the money, which just creates future problems.
It’s your money, so it’s your decision.
That’s our show for today. A full transcript of today’s show can be found at hoyes.com, that’s hoyes.com, and more thoughts on this topic are in Chapter 21 of my book Straight Talk on Your Money.
Thanks for listening, until next week, I’m Doug Hoyes, that was Debt Free in 30.