5 Considerations When Loaning Money to Others
Life throws us curveballs. And sometimes, we need help after striking out. I’ve come across a few situations recently where I was asked to give advice on how a private loan could work. For the people I work with, their willingness to help a friend or family member is both natural and commendable. I work with some pretty awesome, caring and generous people. But willingness and ability to help can be two different things. And there certainly are parts of the process that should be known prior to handing over a check for the protection of both you and the other party.
Here are some things I’ve been talking about recently.
- Can you afford to do it? The interest you could collect on a private loan could be more attractive than the savings rates offered at banks or through certain notes or bonds. But a private loan is also illiquid and could put strain on other parts of your plan.
- Is it a loan or a gift? If it’s a loan, you need to act a little bit like a bank. No bank gives a loan without understanding the repayment risk. Depending on the nature of the relationship, I’d suggest you ask for some financials. No bank lends to greater than a 50% debt to income ratio and you shouldn’t either. You’re doing them no favors if they will struggle mightily to repay you in which case, maybe you need to find a different way to help them.
- Document the loan. Even if it’s the back of a napkin, document the loan and make sure it’s signed and clearly agreed to. Don’t bank on a handshake or a good memory on what was discussed as terms and conditions. What interest rate will they pay, what are the payments going to be and over what period of time? And what happens if they don’t repay or miss payments?
- Consider the “what if” scenarios. If they pass away, what happens? If you pass away, what happens? Is there collateral at play? Would it be better to co-sign a loan with a child instead? What if there is divorce or some sort of other major life change in the middle of the loan?
- Keep it arms-length. In some cases, a private deal is a win-win situation. My church did it when paying off a building addition. Private investors got a better rate than they were getting on cash at the bank. And the church paid a lower rate privately then they were paying at the bank. But if this is more of a favor, make sure the interest is still “fair” (what one party would pay if you weren’t related) or there could be other consequences. There are tax or gifting considerations that could muddy the waters based on “forgone interest.” And note, the interest back to you is, of course, taxable.
If you find yourself in this situation, talk to a financial planner like me. It’s the best way to make sure you’re truly in a position to afford providing help, and that your protecting each other in the process.
This information is not intended to be a substitute for individualized legal advice. Please consult your legal advisor regarding you specific situation. Haas Financial Group, US Financial Advisors and LPL Financial do not offer legal advice or services.
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