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Lending Money to Friends and Family

07 Feb 2017

Should we lend money to friends or family is a question that we are sometimes asked. While it is nice to help people, lending money on an informal basis can be a recipe for disaster. If there is a problem, friendships or family relationships can be irreparably harmed.

Here are some problems that could arise. You may not be able to enforce repayment and if problems occur, your relationship with the borrower may become very difficult. Have a written agreement signed by all parties to record the purpose and amount of the loan, the rate of interest, the frequency and amount of repayments, the time frame for repayment and how late payments will be dealt with. Insist the borrower make repayments by regular automatic payment.

Ask for evidence that they have explored other borrowing options. If the borrower has been turned down, there needs to be a reason. It could be that there have been problems in the past, or that they cannot obtain insurance.

The borrower may already have a large amount of debt that they are struggling with. Make sure you have a verified set of financial statements from the borrower before you even consider the viability of lending him or her money.

What would happen to their debt repayment ability if they lost their job, or had an illness whereby they could not work? If they are having to borrow from you, the chances are that they will not be capable of financially surviving if they got into this situation. Remember that most households will really struggle financially after paying three months of outgoings.

What happens if the borrower uses the money for a different purpose to what you lent it for? Ensure the money is used as agreed, for example by making the payment directly to the third party. This may be, for instance, a builder or a plumber, or an appliance store.

What happens if the borrower dies, or has a relationship breakdown before they repay you? If there is no proper loan documentation the executor may not know about or recognise it. Equally the former partner may not know about it which will cause problems relating to the property relationship.

If you are convinced that you need to lend the money, there are some ways to ensure things have a better chance of going smoothly. Get to know the true financial situation of the borrower. If it is bad, don’t lend. Sometimes it pays to exert tough love even on family members. Throwing good money after bad is usually a recipe for disaster.

Remember money is easily replaced. Relationships with good friends and family are not. Lending money to people you know should only be as a last resort. The loan should be properly documented by a lawyer.

Disclaimer

Steven Barton (FSP 32663) and Susan Pascoe Barton (FSP 32382) are Certified Financial Planners and Authorised Financial Advisers.  Their initial disclosure statements are available free of charge by contacting them on (07) 3060080 or they can be downloaded from www.pascoebarton.co.nz. This column is general in nature and should not be regarded as personalised investment advice.