Why Lending Money To Friends and Family Might Be A Bad Idea

While there are numerous strategies to better your financial situation in 2023, there is one that may have a big impact on both your relationships and your finances: Lending money to your friends and family!

People lend small amounts of money to friends and family all the time. However, larger amounts can become a huge problem for you as lending to people you care about is much different than lending to anyone else. 

To bring this issue to light, we’ve compiled a few reasons why lending money to friends and family might be a bad idea. 

Dependence on trust

Ritika Asrani, owner of St Maarten Real Estate tells us: “You place a lot of reliance on the fact that you know and trust the borrower when you lend money to friends or family members. 

You must take them at their word and have faith that they will reimburse the money in full when they promise to. 

However, this trust might be a naivety, and the person you lend money to may not be able to pay you back, straining your financial position and relationship with that person.” 

Very little or no interest is charged

Frequently, when lending money to friends and family, the rate of interest that the money would accrue throughout the loan duration is never discussed. 

Both the lender and the borrower feel quite embarrassed to consider a different option since there seems to be an unwritten understanding that the loan is entirely interest-free.

They are open-ended 

The majority of personal loans made between friends and family members are open-ended unless you agree to a set payback schedule. 

That implies neither side is aware of the due date, the appropriate payment amount, or if the borrower is required to pay interest.

Harrison Tang, owner of Spokeo says: “Both you and the lender must create your own assumptions about the loan and how to manage it going forward since open-ended loans don’t specify the expectations or duties of either party.

If you decide to give a loved one a loan, be clear about your expectations before giving them any money. 

Discuss repayment arrangements, including due dates, amounts, and if interest will be charged. Even better, put the conditions of the loan in writing and sign a loan agreement.”

Repayment may not be a priority

Repaying your friends and family is usually not a priority since they know how much you value them. 

There aren’t any immediate repercussions for late payments, such as late penalties, high-interest rates, or a bad credit score, since the money isn’t coming from a financial institution. 

In certain cases, borrowers feel less pressure to make on-time loan payments. They may think you’ll understand if they put off paying you back in favor of making an unwise buy.

It becomes your obligation to follow up and request the money back if you can’t depend on the borrower to pay you back. 

This might be challenging without endangering your friendship. You may be more inclined to accept justifications and half-promises when you’re emotionally overwhelmed and have poor judgment.

Bringing up payback may be challenging since you don’t want your loved one to feel resentful, guilty, or humiliated. This is particularly true if the discussion turns into an emotionally charged argument that leaves you both sad and dissatisfied.

If you’ve previously given someone you care about a loan and are unsure of how to get repayment, tread cautiously.

Avoid bringing up the matter in front of friends or family members who aren’t involved since doing so will just make everyone uncomfortable. Choose a neutral location and a one-on-one talk instead. Be courteous and direct while controlling your emotions.

Then develop a strategy together. You may at least agree to a structured repayment plan that benefits both parties even if they might not be able to pay the whole sum in one go.

You might have to co-sign a loan

Tommy Mello, owner of A1 Garage Door Service warns about co-signing a loan.

He states: “It’s risky to co-sign a loan since you can end up bankrupt because of a loved one. If a friend or member of your family co-signs a loan and fails to make payments, you are jointly and severally responsible for paying the whole amount of the loan. 

Make sure you can afford to repay the debt if necessary and that you really want to take on this responsibility before agreeing to co-sign. If you really want to assist a friend or family member out of a tight financial position, go ahead and do it, but know in your heart that the likelihood of being paid back is quite remote.” 

It could encourage bad financial practices

Sometimes the greatest thing we can do for our loved ones isn’t to give them a loan of money, particularly if they already struggle with money management. It could provide a temporary solution, but it might not address their long-term issues.

While it may be important to help them maintain their heating system or fix their vehicle, which the loan may accomplish, you also want them to learn sound financial practices. 

Understanding how to handle their own finances keeps borrowing from becoming a long-term fix and safeguards your connection.

It may cause relationship problems

One of our most significant and essential resources is our relationships. Our most important connections might alter or suffer if we lend money to our loved ones. Percy Grunwald, a financial educator and owner of Compare Banks, has direct experience with this.

“When one family member lends money to another and they don’t pay it back, I’ve seen a lot of different family relationships shift. 

Because certain family members may be more sympathetic than others and one side is pushing for the victim to get compensation, it might seem as if some must choose sides.

When you provide a loan to a close friend or member of your family, they may not see it the same way they would if it came from a bank or another lender. Expectations between the two sides may not match. Typically, nobody comes out of this situation well.”