A new year is always filled with hope and the possibility of our circumstances changing for the better, especially when it comes to our finances.
While there are many ways to improve your finances in 2020, there is one way that can significantly improve both your finances and your relationships – not lending money to friends and family!
I have been both a recipient of loans from family members (my sisters, to be exact) as well as the lender to some friends.
Although there were never any timelines as to when I would return the money to my sisters, we have always trusted one another to do the right thing, and we have.
On the other hand, lending money to friends has always come with very strict conditions and terms of repayment, and is generally something I avoid.
Why should you not lend money to family and friends; and why is this a bad idea for your finances and overall relationships?
From my personal story above, there are a couple of shortcomings that stand out:
1. YOU HAVE TO RELY ON TRUST: When you lend money to friends or family, you rely heavily on the fact that they are a person you know and trust. You have to take their word for it and believe that they will repay the funds in full when they say they will.
2. VERY LOW OR NONEXISTENT INTEREST RATE: Often, when lending money to friends and family, there is never talk of how much interest the funds will bear over the loan period. There seems to be an unspoken agreement that the loan is completely interest-free, and the lender and the borrower feel awkward about discussing an alternative.
3. THERE ARE NORMALLY NO BINDING CONTRACTS: Because there are no binding contracts with clear timelines of repayment, there tends to be no sense of urgency to repay the loan and, added to the fact that the loan is interest-free, a loan to a family member or friend can take months, sometimes years, to be repaid.
4. THE TERMS AND CONDITIONS OF REPAYMENT ARE NOT CLEAR: There are normally no terms regarding when and how you will receive your money back – the agreement is based on when your loved one is financially stable again, and you cannot tell when this will materialise. And, because there is no written agreement, the parties involved don’t discuss what recourse there is for nonpayment – it is just assumed that they will pay you back.
5. YOU LOSE OUT ON THE COMPOUND INTEREST YOUR MONEY COULD BE EARNING: Your money could be in your bank account or in an investment, earning interest. When you lend money and you do not charge interest, your money is idling, but it should always be working for you by earning interest or going towards assets that will appreciate in the long term.
6. NEVER CO-SIGN A LOAN WITH A FRIEND OR FAMILY MEMBER: Co-signing a loan is reckless and you could find yourself financially ruined because of a loved one. When you co-sign a loan, you are severally and equally liable to pay 100% of the loan should your friend or family member not pay the debtor. Before co-signing, make sure you can afford to pay the loan back if you have to, and that you actually want to accept this responsibility.
I reckon that if you do want to help a friend or family member get out of a sticky financial situation, do so, but in your heart know that the possibility of being paid back is very slim.
You have to be ready to write off the debt and still keep your relationship going.
It can be hard to say no to a loved one when you are approached for help, but, sometimes, it is the best for your own finances and your relationships.