Okay, so here’s another truly fascinating money matter – the question of whether or not to lend money to a family or friends. Whilst the easy answer would be an emphatic NO, unfortunately emotions have a way of conquering logic when it comes to making money decisions, especially when it involves our loved ones. I doubt there’s a single reader out there who would feel comfortable watching a family member or loved one suffering financially. And therein lies the big dilemma – do you lend a financially embattled family member or friend money to address a short term need with the risk of losing the relationship (and possibly the money as well!) in the longer term? Lend or lose?
We’ve all heeded the famous warning of Polonius, Chief Counselor to King Claudius in Shakespeare’s Hamlet where he says, “Neither a borrower nor a lender be, for oft loan loses both itself and friend.” The glaring reality is that we ALL know (sometimes through first-hand experience) or have read about the dangers of lending money to family in friends. Shakespeare knew it, too, over 400 years ago. In fact, King Solomon who wrote the Book of Proverbs knew the dangers of lending money almost 2 500 years ago when he wrote, “The rich rule over the poor, and the borrower is servant to the lender.”
And therein lies the very essence of why lending money to a loved one can be disastrous. The loan itself has the potential to dramatically change the very nature of the relationship between two people. Whatever the relationship was before making the loan, the very essence of the relationship is completely redefined by the fact that one person becomes ‘the borrower’ and the other person becomes ‘the lender’ (or in the words of King Solomon, ‘the servant’). And we’ll explore the manner in which the borrower-lender relationship deteriorates over time shortly.
Assuming that at some stage in our lives we’re going to allow our emotions to override our logic and become the “lender” in our family or friend relationship, here’s some cautionary advice on what to be careful of together with some tips on how to manage the loan (and the relationship) so that both survive the transaction!
- Don’t enter into an open-ended agreement: If you agree to lend your loved one money, the wisest step you can take is to reduce your agreement to writing. If you think this sounds too ‘formal’, you’re right – it is formal! You are agreeing to lend your hard-earned money to another person, so make it legal and put it in a contract. The contract doesn’t have to be complicated, but there are certain issues that must be covered in the contract which include (a) the agreed interest rate, (b) the monthly instalments, (c) how and where payment must take place, (d) when the loan period ends and (e) any repercussions for non-payment. If you feel inadequate or embarrassed about putting the terms of the contract in writing, suggest to your friend that you get a third party to mediate the agreement and draft the contract. As the lender, you may feel that it is inappropriate or even rude to ask for interest or for fixed period for the loan for fear of offending your friend. The truth is that you have feelings and emotional attachments to your friend, whereas an independent party will be able to give the two of you completely objective advice that protects the interests of both the borrower and the lender. Bear in mind that it can be incredibly stressful having to impose a business transaction onto your friendship, and a level-headed, independent party could help you remove the emotions and focus on the facts.
- Give the loan priority: A common mistake made by many lenders is that they aren’t upfront with the borrower about when they’d like to be paid back. Because talking about money is such a sensitive matter, we tend to avoid discussing the loan in too much detail. I find this area of human behaviour so fascinating. We can have the most intimate discussions with our friends about the most intensely personal aspects of our lives, and yet when it comes to money we skirt around the topic in the most peripheral terms! How on earth did we mutate into a generation of people who can openly discuss sex but fear the very mention of the word money? My advice is to be completely honest about when you need (or would like!) your money back. Whatever you do, don’t leave the borrower with the impression that there’s no rush to pay the money back. This form of open-ended agreement can only lead to unnecessary heart-ache and despair. The borrower may feel that the loan repayment is not a priority and will therefore not rush to repay the loan. You will, most likely, build up resentment towards the borrower for not paying the loan back quicker. Your resentment could well be misunderstood by the borrower, and so the cycle of misunderstanding, mis-communication and hurt continues until eventually the friendship becomes too awkward to continue. All the heartache and hurt could so easily be avoided if both parties were open and honest upfront.
- Overcome your fear of asking for your money: If you’re even thinking about lending a friend money, overcoming your fear of asking for your money back is something you’re going to have to learn to do. Whether your agreement is in writing or not, there may come a time when his repayments are late or long overdue which will force you to brave the big question. If you don’t think you’ve got what it takes to ask for your money back (or at least remind your friend that he owes you money), then you need to prepare yourself for the inevitable consequences – feelings of resentment, awkwardness, guilt and possible estrangement. My advice is that, before you agree to lend the money, make sure that you’re strong enough to ask for your money back if necessary. If not, be prepared for the internal debate which goes something like this: If I ask for my money back, I may lose a friendship. If I don’t, I may lose what’s rightfully mine.
- Agree to keep the loan private: A loan agreement between two people is an intensely private matter – make sure you keep it that way! Whilst money itself has no power, the intense feelings involved in borrowing and lending money (especially within a family or friendship circle) have the potential to alienate, humiliate and anger in the most destructive manner.
- Be aware that it can make family or friendship gatherings awkward: And so it goes without saying that the more people who know about the loan, the more strained and awkward your social gatherings can become. Every member of the family (or circle of friends) has heard a different version of the truth, each person has their own opinion on the matter and (such is human nature) people respond by either sympathising with the borrower or the lender. As a result, your group becomes polarised and divided along lines of individual loyalty, and so the rift begins is treacherous (and sometimes inevitable) course.
- Beware of the lender-servant relationship: We have proof that even long before Jesus was born, healthy human relationships had the potential to degenerate into the sorrowful lender-servant relationship trap. King Solomon warned us against the dangers of lending to loved ones for this very reason. This lender-servant relationship is another fascinating area of human psychology wherein it’s been proven that, whilst the borrower develops intensely strong feelings of being ‘servant’ to the lender, the lender generally doesn’t reciprocate feelings of being ‘master’ to the borrower. It is very much a one-sided, emotional pitfall of guilt and misguided loyalty that is experienced intensely by the borrower. It is these feelings of intense guilt and of owing something more than mere money to the lender that can alienate and destroy friendships.
- Be careful not be to an enabler: A notable point to consider is that, if a person cannot borrow money from a traditional lender (such as a reputable financial institution), he may not be able to produce a credible credit record. Always keep in mind the reality that loaning money (in most instances) is a temporary fix. If your friend can’t pay his bond this month, what is he going to do differently next month to ensure that he can? Financial troubles are generally a sign of ongoing, underlying problems or issues that need to be addressed and fixed. By agreeing to lend your friend money, you may well be the enabler – the person that is enabling him to continue managing his money incorrrectly – and thereby prolonging and increasing your friend’s financial woes. Which leads me to the next point…
- Try to help the financial situation in other ways: If, by lending, you feel as though you’re exacerbating the problem and enabling the borrower’s money woes, then I’d strongly recommend reconsidering making the loan. What is your loved one or friend doing wrong that he has encountered financial problems in the first place? Is he living beyond his means? Does he need help drawing up a budget? Does he need help managing his business? Does he have a spending problem? The most appropriate, long-term solution may not involve lending him any money at all!
- Make sure you don’t need the money: It may seem obvious, but before lending anyone money, make sure you’re not going to need the cash in the near future. No matter how small the value of the loan, it’s essential that you’re not going to need access to the cash before the expiration of the loan period, or any time soon thereafter. This point really serves to drive home bullet point number 2. Do yourself a favour – make the repayment of the loan a priority. Make it clear when you need the money back. And don’t even consider lending the money if you’re going to need it any time soon.
- Don’t compromise your morals and your principles: One of the recurring opinions on the topic of lending to loved ones is this: If you loan the money, be prepared to write it off. If they pay it back, it’s a pleasant surprise. It they don’t, you never expected it back in the first place. I’m going to be completely controversial here and disagree with this statement wholeheartedly. Why? Because making the decision to lend money should not force us to compromise our own morals and principles. Regardless of who you lend money to, the facts remain – (a) it is your hard-earned money, (b) it rightfully belongs to you, (c) you were asked for a loan, not a donation and (d) a promise is a promise.
You may have an emotional connection to a loved one, and you may very well be convicted to lend that person money. Having weighed up the facts of the matter, you may reach the conclusion (driven largely, no doubt, by emotions) that a loan is the most appropriate course of action. Before you do so, please take heed of the advice dispensed above – least of which is to not compromise your principles and to make sure you’re not the enabler of his financial woes. The real solution may lie in the very wise words of W. L. Bateman, “If you keep on doing what you’ve always done, you’ll keep on getting what you’ve always got.”
Categories: Lifestyle Financial Planning