How to deal with family members looking for loans

IT IS one of those conversations which stops you in your tracks. You’re put on the spot, you have to answer and, frankly you don’t know how to respond.

Yep, it’s about money. That awkward moment where a friend or relative asks you to lend them money.

If it’s only a few bucks, maybe even a hundred or two, then it’s usually OK.

But if it’s thousands of dollars to help the borrower buy a car, put a deposit on a house or even start a business, then things start to get a bit more serious. And it can put you in a very tough spot.

The closer the relative, the tougher the spot you’re in. Because they assume that because you know them so well, you will automatically come up with the cash.

What if you say “no” and it damages your relationship? What happens if, despite the borrower’s best intentions, they end up not being able to pay you back? And what if it ends up affecting your own financial situation?

Lending to friends and family is a minefield of potential problems, so before you even think about saying yes, here are six things you need to consider.

1. The initial response

Those first words in response are just so critical … but never, ever commit upfront.

The decision needs thought, more detail and a plan. So that first response has to be polite, friendly, encouraging and noncommittal.

You’re buying yourself time and raising the possibility of a future rejection.

So keep it neutral. Something along the lines of;

“Let me talk to my accountant and bank manager.”

Or

“I’d love to help but I need to just check my own finances because I’ve had some big expenses and a few coming up. I’m not sure I have the spare cash.”

Or

“That sounds a great idea for a business; why don’t you send me a business plan and I’ll get my accountant to look at it”.

You get the drift. Delay the decision and bring in another element (like an accountant or bank manager) which you can use as the reason for a rejection in the future.

2. Can I afford it?

The fact that someone is asking you to shell out means they’ve probably made some assumptions about the strength of your financial situation compared to their own, but we’re willing to bet they don’t know your full story.

So the first step in your decision making process is a realistic assessment of whether you can actually afford it. Ask yourself “Can I afford to lose this money?” and what you’d have to sacrifice if the money wasn’t repaid.

Always protect your family first, and don’t put yourself in a situation that could jeopardise the financial security you’ve worked so hard to create.

Blaming a big mortgage, an upcoming overseas holiday or other big expense is a great excuse for not having any spare cash.

3. Can they pay me back?

A ‘loan’ that the borrower has no hope of repaying is actually a gift, and a generous one at that.

So unless you’re feeling particularly charitable (where you don’t get a tax deduction), you need to be realistic about whether they can actually repay the money.

Think about the character of the person asking for money, talk to them about how exactly they’re going to manage the repayments, and don’t accept vague or unconvincing answers.

Ask them to provide you with a budget on their family finances and ask that they provide you with a monthly update to see whether they’re sticking to the plan.

4. What are the alternatives?

Banks and other financial institutions make their money from lending.

They have a comprehensive lending process that lets them fully assess a potential borrower’s ability to repay a loan, or their creditworthiness.

It could be better for everyone involved if the borrower approached a bank, which will take the emotion out of it and reduce the risk of personal problems down the track.

If they’ve already approached a bank and been rejected, then you should be very careful about agreeing to lend to them privately.

The bank has knocked them back for a reason. Maybe ask to see their credit report and credit rating which they can easily get from www.getcreditscore.com.au.

5. What will happen if I say no?

There’s always the potential to harm relationships when money gets involved.

Every situation is different, so think about yours carefully and weigh up the importance of being loyal to someone close to you compared to protecting your financial situation.

If you can’t afford the loan, or it will put you in financial jeopardy if it’s not repaid, then sit the borrower down and explain why. You might find that you’re able to help them in other ways.

6. What will happen if I say yes?

If you do decide to say yes then it’s crucial to formalise the agreement so that both parties are on the same page.

Document the terms of the loan, including the amount provided, the parties involved and the repayment schedule, and have the borrower sign a copy.

This will ensure that there is a clear reference point if things go wrong down the track and give you peace of mind, too.

You should also have the ability to repossess the asset if the loan isn’t repaid. A bank will so why shouldn’t you.

If the money is to finance a new business then ask for a monthly meeting and management accounts to track the business’ progress.

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