Lending and Borrowing

The following is an excerpt from Your Money: The Missing Manual, an excellent book written by JD Roth from Get Rich Slowly. Copyright 2010 O'Reilly Media, Inc. All rights reserved. Used with permission.

"Neither a borrower nor a lender be," Shakespeare wrote in Hamlet, "For oft loan loses both itself and friend." When a friend or family member asks to borrow money, your first inclination is probably to help out. But many people have learned the hard way that friendship and finances don't always mix. You can save yourself a lot of grief by knowing in advance how you'll handle these situations.

Some people decide that they'll never make personal loans: They know that if they're asked, they'll simply say, "Sorry, but it's my policy never to lend money to people I know." If you think this is harsh, you can follow it with something like, "But I'd be happy to help in some other way, if I can. What do you need?"

Note: Think very carefully before co-signing on a loan. As a co-signer, you're legally obligated for the debt, so if something goes wrong, you'll be stuck with the payments, a black mark on your credit report, and a broken friendship. If you want to help, it's usually better to lend money than to co-sign.

Not all loans between family and friends end in disaster. In fact, although there aren't any stats on the subject, it's likely that most loans go smoothly. But the potential for trouble is so great that you should think twice before lending (or borrowing) money. Ask yourself what would happen if the borrower never repaid the loan. How would it affect your finances—and your friendship?

You're likely better off saying "no" rather than putting yourself in a position where you have to hound a friend for money. Which would make you feel worse: the momentary pain of telling a friend "no," or the ongoing anguish of having the loan destroy the friendship?

Despite these warnings, there will undoubtedly be times you're tempted to lend money. When you do, be smart about it:

• Discuss other options. Is there any other way you could help your friend? Sometimes people think money is the only way to deal with problems when there are actually other solutions.

• Only lend money you can afford to lose. You may never see the money again, so don't put your own financial well-being on the line just because you feel sorry for your cousin Joe. Make sure you're taken care of before you lend money.

• Be clear about your expectations. Draw up a payment schedule and discuss what happens if something goes wrong.

Tip: Use this loan calculator at Bankrate to create a payment schedule: http://tinyurl.com/BR-loancalc.

• Get it in writing. Don't just hand over the money without some sort of record. At LawDepot.com, you can fill out a web form, and for 12 bucks you get a completed promissory note. There's also a free sample template at Expert Law.

• Deal with problems right away. You may feel like a nice guy by not reminding the borrower that they're 30 days past due, but you're just setting yourself up for trouble. Keep the lines of communication open.

If you can afford it (and it doesn't seem weird), consider giving the money instead. That way there's no ickiness on either side. If your friend pays you back, great; if not, you can feel good about helping her out. And remember: It's always okay to politely refuse.

At some point, you may be the one borrowing money from a friend or family member. (You should do this only if you can't boost your income or tap an emergency fund.) When you borrow, explain exactly why you need the money, put the deal in writing, and then stick to your word.

Keeping your word is the most important part. That means repaying the loan as promised—or sooner, if possible. Take this as seriously as you would any other financial obligation; in fact, take it more seriously. If you don't pay the bank back, you'll damage your credit score. But if you don't pay back a friend, you'll damage that friendship and your reputation.

Don't make promises you can't keep: If you say you're going to pay back an extra $200 when you get your Christmas bonus, do it. And use the borrowed money for the stated purpose. If you need cash to buy a car because yours was just totaled, then buy a car; don't go out and use the money to buy a new plasma TV. If your friend comes over and sees you have a new car and a new TV but you haven't been making your payments, it's going to make his blood boil.

Comments

[Budgeting in the Fun Stuff]

As someone has both borrowed from and lended to family and friends, I'd avoid it if at all possible.

Borrowing from my parents led to resentment and lending to a friend meant she stopped talking to us when she stopped paying us back.

I wouldn't co-sign a loan either...