When it comes to lending money to friends or family members, a person has to deal with emotional and financial challenges that can be complex and unexpected. Although lending to loved ones is often motivated by compassion and a desire to help, this can lead to challenges and complications that may negatively affect relationships.
Forbes writer Cecily Jones discussed this topic in detail by sharing her experience with a couple who borrowed a large sum of money from their parents to buy a house.
The emotional impact of lending money is often underestimated. Jones reviews the case of a high-income couple who borrowed money from their parents, but did not commit to repaying the amount as agreed upon, which reflects a lack of respect for the terms of the original agreement.
Jones explains that this type of situation may lead to an imbalance between parties, tension, or even a loss of trust and intimacy between loved ones.
Lending money can also create a sense of superiority or control, as the lender feels entitled to interfere in the borrower’s financial decisions, which may lead to disagreements or isolation. Jones points out that the resulting emotional damage may be more severe than the financial loss itself, and therefore advises the need to carefully consider the impact of this decision on the relationship before making any financial commitment.
Financial considerations
Financially, lending to loved ones can have big implications. For those who are not very wealthy, loan recovery is often vital to their financial security and future planning. Jones stresses the importance of assessing the borrower’s ability to repay the loan, especially if he has been rejected by banks due to his bad credit history.
Jones explains that if the loan is not repaid, the lender may face tax complications, as the IRS may consider the amount a gift, resulting in additional tax liabilities.
There is an opportunity cost to consider. The lent money may have been invested elsewhere, generating significant financial returns over time. For example, if he invested $100,000 with an annual return of 10% for 5 years, it would have grown to about $161,51. This potential loss of return is a critical aspect that is often overlooked when deciding to lend to friends or family members.
What are the alternatives?
Jones suggests exploring other alternatives if lending money seems risky or emotionally stressful. One option is to make a gift instead of a loan, as this eliminates the stress associated with repayment and can be simpler for both parties.
Or, for example, the option of participating in a loan can be considered, as this can increase the borrower’s chances of obtaining a loan from the bank without having to lend money directly, although this option carries some risks in the event that the borrower defaults on repayment.
Documentation of the agreement
If you decide to go ahead with lending money, it is necessary to formally document the agreement. The terms and payment schedule must be specified in writing before any amount is transferred. Jones points out that working with lawyers and financial experts can ensure that the agreement is comprehensive, reducing the chances of misunderstandings or disputes in the future.
The decision to lend money to loved ones must be carefully considered, with the emotional and financial consequences carefully taken into account. By following advice, documenting agreements and seeking professional advice, you can protect financial interests and ensure that the lending process does not turn into an unexpected problem that negatively affects relationships and money.
