I have very few fundamental rules of personal finance that I follow. Spend less than you earn is a big one, but once you get past that, there tend to be exceptions to most rules in life.
However, there is one principle that I’ve followed for a long time that has never guided me wrong. I do not lend money to friends or to family.
The reason is simple. I don’t want a friendship or a familial relationship to become a lender-borrower relationship.
First of all, no one likes making debt payments. If you owe someone money, you now have the obligation to make debt payments to that person. Some people may be able to constrain negative feelings here, but others may not.
The real problem occurs when a borrower can’t (or won’t… or chooses not to) make a payment. In a normal lender-borrower relationship, there’s no personal connection to prevent the lender from putting pressure on the borrower to pay the loan back. The lender can pursue legal action, report negative information to the credit bureaus, and engage the borrower with lots of phone calls and letters.
Do you want to besiege a friend with threats of legal action, reports of negative information to credit bureaus, or harassing phone calls and letters?
Just visualize it for a second. Picture a friend or a close family member. What would you do if you loaned that person a significant amount of money and that person just decided not to pay you back? “Oh, they’d never do that” is just dodging an uncomfortable question.
To put it simply, loans and personal relationships don’t mix. Yes, some people might have seen success with such situations, but that only happened because the borrower was able to successfully repay the loan with ease. What happens if the borrower can’t do that? Or, for some reason, won’t do that? What if the relationship ends for other reasons and the borrowers “gets revenge” by not paying?
My solution to these problems is to never lend, but occasionally gift. If I see someone I care about in a moment of need, I will help them with a gift. I’ll simply tell them that I do not expect them to repay me, ever, and that this gift is being made because of the friendship they’ve provided over the years. If they decide later on to repay me on their own, I would accept it, but I don’t expect it in any way.
This brings us around to the parent-child dynamic. Does this hold true for parents and children?
For example, what should I do if a child comes to me and asks me to take out a loan to help them to attend college, and that request comes with a promise to repay me? What if the same situation is true for seed money for a small business?
Even in these cases, I would not be in favor of lending money. Having said that, however, we are planning to gift them money. We’ve established 529 college savings plans for each of our children and we dutifully fund them each month. That money is a gift to our children to aid with their education.
If Sarah and I did decide to take out a loan to help a child with educational expenses – something we hope to avoid entirely – we would not expect a dime from our children in repayment. Any money we use to help our children launch their careers and adult lives will purely be a gift.
Why? Again, we don’t want the additional strain of a lender-borrower relationship on top of our parent-child relationship with our adult children. The risk of damaging the parent-child relationship because of problems with the lender-borrower relationship is too high.