Should you bail out friends and family?

“Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.” – Hamlet Act 1, scene 3, 75–77

Perhaps Polonius had the right idea? When a loved one asks for money, it can put you in an awkward position. As Shakespeare warns, loans can end up costing more than the money — they can also damage relationships and enable other’s bad financial habits.

Still, it’s hard to say no when a loved one is in financial need. There are no easy answers to this dilemma — that’s why lending money to family members and friends is still a hotly debated subject in the financial media. Here’s what experts say you should do if you’re asked for money.

Ask the right questions before you decide

It may be tempting to agree right away, but experts warn to take time to think it over and discuss it first. For instance, consider:

Can you afford it? Yes, you should put your financial well-being first. The sad fact is a lot of loans to friends or family aren’t repaid promptly — if they are repaid at all. Most experts warn to lend only as much as you’re willing to lose. Even if your recipient is reliable, an emergency or extenuating circumstances can get in the way. Some experts suggest making a gift rather than a loan, and be mindful of what you’ll be sacrificing now and in the future.

Drawing on your nest egg or emergency fund is a also big no-no as it can put your own financial stability at risk. Also, watch out for “opportunity costs”. That $10,000 loan could cost you significantly more when you consider lost investment income.

How will it affect your relationships? Some experts take the above advice one step farther: don’t loan money to someone who’s relationship you can’t afford to lose. Lending money changes relationships and often breeds resentment, and the consequences can extend to other family members too. For instance, how will the loan affect your relationship with your friend or relative? How will you feel if the loan isn’t repaid promptly? Will you be able to “let it go” if you see the money being spent on non-essentials?

Also, be aware that you could be setting a precedent. If you help out one child, will his or her siblings expect the same courtesy? If you loan money to one friend, will others ask too?

Why is the money needed? Unlike the bank,you won’t have the person’s financial statements and credit score to help you weigh the risks so you’ll have to ask some tough questions and consider how trustworthy your loved one is. Have a frank conversation with your potential borrower and find out why they need the money and what they plan to do with it. The money could help start a new business, pay for someone’s education or help someone who is struggling temporarily due to a job loss or illness.

On the other hand, it could wind up enabling someone who has out of control spending habits. In some cases, your loan may be a quick fix that exacerbates debt problems rather than helping to solve them. Consider his or her track record of handling credit — are you likely to get your money back?

Furthermore, why is this person coming to you for money? Are there any other options, like a bank loan? Has this person been turned down, and why?

What are the terms? A bank would never say “pay me back when you can”. Likewise, experts warn would-be lenders to consider the terms before opening their wallet. For example, talk about how and when a loan will be repaid. Will there be a payment schedule for larger sums, or will money be paid back by a certain deadline?

Also important: what are the consequences of missing a payment or deadline? Experts note that when terms are set, both borrower and lender are more likely to take the loan seriously — especially if interest is involved.

What are the legal and tax ramifications? Depending on where you live, certain tax laws may apply to money that you loan or give to another person. For instance, some countries like the U.S. require that interest be charged, otherwise the sum could be taxed as a gift. Also, you may be able to write off  a defaulted loan if you have proof. Find out what the rules are for your area — and enlist the help of a lawyer or accountant to help.

While no one wants to think about dying, what happens to the loan if something happens to you before it’s repaid? If you’re lending to someone who is in your will, you can choose to deduct the amount of the loan from their inheritance, for example.

If the answer is “yes”, proceed with caution

If after careful consideration you decide to go ahead with the loan, the best thing you can do is to decide on the terms and draw up a formal agreement. Having the details “in writing” adds another layer of accountability and protection.

However, a simple I.O.U. won’t cut it. In addition to the date, the amount of the loan and the signatures of both parties, your contract or promissory note should include:

– a specified date when the loan is due (or dates when payments are due).

– the amount of interest charged and the total financing charge (i.e. the amount of interest paid). If you aren’t charging interest right away, the contract should include the date when interest starts.

– any procedures or actions to take if payments are missed or the borrower defaults on the loan.

For extra protection, you may want to have the contract notarized or have the transaction handled by an attorney — especially if you require collateral for the loan. Don’t let awkwardness stand in the way of this step. If asked for an explanation, say your accountant, adviser or lawyer requires you have a written document, or that you need one in case you’re audited.

In addition, be sure to keep records of everything involved with the loan — like proof of payment or any  steps you’ve taken to recoup your cash.

If the answer is “no”, give it promptly and gracefully

It can be hard to let down someone you know, but a “no, I can’t right now” is all that’s needed. You don’t have to go into details, and you may want to keep your own financial situation private. If you feel some explanation is required, choose your words carefully. You’ll want to avoid damaging the relationship by implying the person is untrustworthy. (For more tips, read “The art of no“.)

If you’re going to say no, do it as soon as possible so your loved one isn’t left guessing.

Even if you can’t lend financial support, you can still help in other ways. For example, offer to share your financial savvy and money management skills. Pay for a session with a financial planner, or watch the kids while they put in some overtime to tackle their debt. If your loved one is unemployed, help with the job hunt — you might just know of someone who is hiring. Gifts of food or gift cards can help cover some of the necessities.

Regardless of the advice of financial experts (and Shakespeare), everyone’s situation is different and you shouldn’t feel pressured — or guilty — about your decision. Ultimately, whether you say yes or no is a personal choice, but it’s a choice that deserves some thought and careful planning.

Sources: Bankrate.com, David Ramsey.com, Equifax.com, Montana State University: Lending Money to Family Members, National Foundation for Credit Counselling,

Have you ever loaned money to someone you know? Share your tips and experience in the comments below.

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