How to Respond if a Family Member Asks for a Loan (Part 1)
This is part 1 of a discussion of my views on how you should respond to a request by a family member for a loan. In today’s economy with so many people living paycheck to paycheck (and still falling behind), it is not unusual to be asked by a friend or family member for a loan.
There are a wide variety of responses and strategies that can be used if you are asked for such a loan. Loaning money to friends rarely works out well for either party. When it is family that needs money (or at least they think they do), the guilt, sympathy, and desire to help can be powerful forces. The response you should provide to a family request for money will depend on a number of different factors including:
- Your financial ability to make a loan without jeopardizing your own financial obligations
- The purpose of the loan
- The history of the family member in the responsible handling of money, including any prior requests for loans
- The ability of the family member to repay the loan.
Here are some of the responses you can make to a request for a loan by a family member.
Just Say No
a. You are in no financial condition to make a loan to anyone, even if the money is likely to be paid back over time. Making a loan under these circumstances is likely to put you in the same boat with your family member, which benefits no one. This will probably create extreme stress on both family members and may cause such emotional trauma as to permanently damage the family relationship. In this case your first response should be:
“I am sorry you are having money troubles. That is a lot of money to me but I will consider your request and provide an answer quickly, as soon as I have a chance to study my own financial situation.”
Shortly thereafter you tell your family member:
“I have carefully looked at my own finances in light of your request and need. I am sorry, but my finances are presently stretched to the limit and there is no extra money that I can lend you.”
No reasonable family member can be offended by such a response, particularly when you offer additional helpful advice as will be discussed in part 2 of this post. You should not feel guilty about taking this completely honest and legitimate position in response to a loan request from anyone.
b. You are legitimately concerned about the ability of your family member to repay the loan and you cannot afford to have the “loan” end up as a “gift.” For example, you may have some savings that you worked hard to put away as an emergency fund or as college savings for your children. If you were to lose this money in a “loan” that is not repaid by your family member, it might be difficult or impossible for you to catch it up in a reasonable period of time. In this situation, you should truthfully respond as follows:
“I know you are in a tough spot right now but unfortunately so am I. I am sorry but I simply do not have any available funds right now to make a loan to anyone.”
Once again, this response is 100% truthful and legitimate. You should not feel guilty about it.
c. You can afford to make a loan but your family member intends to use the loan proceeds for a purchase that any objective observer would agree is unnecessary and unreasonable. Such purchases could include: (a) taking a frivolous vacation; (b) purchasing a new car to replace a properly functioning older car, using a lame excuse for doing so; (c) buying any other luxury item such as a new appliance, etc. In this situation, tough love will be necessary so that you do not enable your family member to continue a pattern of bad money behavior. In some cases, this kind of tough love will benefit your family member in the long run. You can probably assume that the family member came to you for a loan because their poor credit history prevents them from using normal credit sources. There is no good reason for you to add to the problem by assisting the family member in going further in debt. In this situation your truthful response should be:
“Although I do have money set aside for emergencies, this does not appear to be one of those emergencies I would feel bad if I were unable to help you, my own family, or another extended family member in a true emerency situation because I had used my emergency money for a non-emergency like this.”
I should point out again that this is a truthful response based on logic. There is no need for, or benefit to, being deceptive or untruthful with your family member. However, at this point you have an important decision to make. One option is to state your views to the family member about the overall wisdom of the family member’s proposed purchase, hoping to discourage the purchase altogether. If you do provide friendly “advice” that your family member simply cannot afford the purchase, you are likely to create resentment and even hostility that could last a long time. It stands to reason that if the family member was at all receptive to negative feedback about the proposed use of the loan proceeds, he or she probably would not have asked you for the loan. If you think that this is the case, you can instead refer the family member to other loan resources that I will talk about in part 2 of this post.
Make the Loan
If you an afford to make a loan, and if it is for a legitimate need, and if you can afford to lose the money, making the loan is a nice gesture toward the family member. However, you must still consider the probability that the relationship with your family member will change because of the debtor-creditor relationship. This change in relationship is almost universally negative and often permanent. To perhaps prevent this from happening, you can instead offer the needed money to the family member as a true gift. I would tell the family member something like this:
“I would like to give you this money to help you out of this money crisis that you are having. When your finances improve, you may give the money back if you wish, so that it will be available for possible use in other similar circumstances.”
If this is done in a low key manner, the intimacy of the family relationship may be preserved because once the money is given, there are no lingering expectations on either side that can create a continued stressful environment.
If you want to help out your family member but due to the size or nature of the request you do not want to make an outright gift, you can take the risk of providing the money as a true loan. If you do this, I highly recommend that you formalize the loan transaction. There are three good reasons for doing this. First, using formality in the loan transaction (including formal loan documents) clearly establishes the terms and obligations of the loan repayment. This, in turn, reduces the risk of harsh feelings between you and your family member have different internal understandings about how and when the loan will be repaid. Second, using formality in the loan transaction will actually separate to some degree the debtor-creditor relationship from the family relationship. By doing this, you decrease the risk that the family relationship will be damaged. Third, formality in the loan transaction can prevent unintended tax consequences such as imputed interest income or gift taxation.
There are a couple of good ways to formalize the loan transaction. The simplest way is to use a basic promissory note. You can find simple to moderately complex promissory note forms online for free or for a small fee at sites such as legalzoom. You can also get promissory note forms at office supply stores and maybe even from your banker. Fill in the terms of the loan completely and have everyone sign it. Make sure that both you and the family member have a copy.
Another way to formalize a loan to a family member is to use one of the peer-to-peer direct loan sites that have become available on the internet. I will talk about those in part 2 of this post.
To contine reading about responding to loan requests from family members, you can go to part 2 of this post.