The next time you get cornered by a needy friend or family member needing to borrow money—or the next time your heart compels you to lend out of generosity—here are some basic rules to keep in mind.
First of all, don't get carried away.
You may be elated at the opportunity to share your riches with everyone, but keep in mind that you probably want to keep some for yourself, too. Depending on which family member or friend you're lending to, chances are you may never see the money again.
On that note, only lend the money you can afford to lose. "Only lend up to the amount of money you’d feel comfortable placing on the table in a game of roulette or craps," says Next Avenue.
Once you decide how much your debtor can be trusted with, write it down. Record how much you've lent, when it should be paid back, how it should be paid back, whether there will be an interest charge, and have both parties sign it. However formal it may seem, it will prevent any misunderstandings and feelings of being exploited, it will serve as a reminder, and ultimately preserve your relationship and your wallet.
Cheryl Krueger, owner of Growing Fortunes Financial Partners in Illinois, suggests that you consider charging interest if you are lending a larger sum of money. In this risky business, charging interest will give you something to be excited about, plus your borrower won't feel like such a scrounger. Best of all, you will avoid any tax problems.
"What you may not realize is that if you aren't charging interest, you are making a taxable gift of the interest that you waived," she says.
The US Internal Revenue Service expects the minimum interest charge, or the Applicable Federal Rate, to be 0.48 percent for loans up to three years; 1.82 percent for loans between three and nine years, and 2.82 percent for loans over nine years, according to Next Avenue.
Next, have a backbone. Ask what the money is for, and how the borrower intends to pay you back.
"If you have a relative and you really don't approve of what they're asking for or feel that it will enable irresponsible behavior, you should think twice about extending money to them, " says Suzanna de Baca, vice president of wealth strategies at Ameriprise Financial.
If the same relative keeps asking for loans without paying you back, you have every right to say no. Just because they are family or friend doesn't mean you are obligated to keep helping them out. Ultimately, by continuing to lend to an unreliable borrower, you are encouraging irresponsible behavior and delaying them from getting on their own feet.
If you find it hard to say no, spend some time calculating how much money you can make by keeping the money and investing it in stocks, and then go talk to the requester. For example, a $20,000 loan now could be worth $300,000 30 years from now if you invested in stocks with average returns, according to Next Avenue.
Last, but most importantly, don't allow financial agreements/disagreements to get in the way of your otherwise harmonious relationships.
Consider the well-being of your relationship while setting terms, and if you never get paid back, accept that this is a part of the lending process.
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