This article first appeared at US News and World Report Money.
A friend or a family member is struggling with a financial problem. That person comes to you and asks you to lend money to help them through their crisis. What do you do?
This situation comes up quite often in tightly-knit families where there are different levels of financial success. A struggling person will often look to close family members for help in a crisis.
My solution is a hardline one. I don’t lend money to family or friends, no matter what. For many people, however, this is an undesirable solution. Perhaps they do want to help, or perhaps they have difficulty saying no.
Here are four important steps to consider if you are considering lending money to a family member or friend (or have recently done so).
Decide how important repayment of the loan is to you. If a family member or friend is coming to you for a loan instead of a financial institution, the odds are that the person does not have strong enough credit to seek a loan via traditional means. Like it or not, that means that the person has some risk of not being able to repay the loan. When you give that person money, no matter what you do, it might not be repaid easily.
Assuming you’ve already decided to give the person help, you have to ask yourself how important it is for that person to repay you. Is the relationship more important? Or are you more concerned about repayment? If they slip from their scheduled repayment plan, you’re going to have to go down one road or another. You’re far better off deciding before it gets to that point so that emotions don’t get in the way.
If it is very important, get the terms of the loan written down, signed, and notarized. If you’ve decided that you’re going to insist on full repayment, draw up an agreement stating the terms of the loan. This is called a promissory note. Here’s how to draw one up.
Why should you do this instead of just trusting a handshake? A handshake won’t stand up to legal efforts if you need to pursue repayment in that fashion.
Your best option is to go through this process before ever handing over the money. Require that a promissory note be signed and notarized by both of you before you’ll hand over the money that the other person wants.
If it is less important than the relationship, think of the loan as a gift. If you’ve concluded that you’d rather have a relationship with this person than get all of your money back, shift your thinking about the loan. Consider it a gift rather than a loan.
A gift has no requirements at all for repayment. If a person chooses to repay you, that’s up to them, but there’s no need for them to do so.
If money is given as a gift, then you don’t have to worry about nagging the person for repayment or moving through legal channels. However, the money you gave to that person must be considered a complete loss.
If a loan is unpaid, don’t let the issue sit around unresolved. What do you do if a relative or friend has borrowed money from you but isn’t repaying you? You need to decide – and quickly – whether or not you’re simply going to consider the loan a gift or you’re going to actively pursue repayment.
The longer you allow the loan to sit there unpaid while you have negative feelings about the situation, the greater the damage you’re going to do to your relationship with that person. You’re going to build up a great deal of negativity toward that person if you just let this sit.
Spend some time thinking about whether you want to pursue this legally or whether you want to just let the whole thing drop and write it off as a gift. The worst thing you can do is let the situation sit around and fester into something that could tear a family apart.