There is a reason’they say’ “don’t lend money to friends or relatives“.
It can be tempting to ask family or friends for a loan; especially if you know that they have the available funds. It can be equally temping to offer to loan money to a loved one in need. The Borrower needs to seriously consider how the loan with impact both parties’ relationship. It can be very awkward to the lender when approached for a loan, especially if the loan is for $1,000’s.
Factors to consider:
- Buy yourself some time and keep the response neutral and friendly, such as: “I need to check my finances as I have some big bills coming up” or “Sounds like a good idea – let me talk to my accountant.
- Can you really afford it?
- Can the borrower really be able to pay you back? Perhaps some questions to the borrower as to how they exactly can they manage the repayments. You may become the villain if you have to ask for repayments. Perhaps you are retired and will rely on that monthly payment.
- Can afford to lose it if the money is not repaid?
- Has the borrower tried to obtain a loan from a financial institution first in order to save the stress of asking family or friends for the funds?
- What will potentially happen if you have to say ‘no’? Perhaps you can help the borrower in other ways instead.
- What happens if you decide to say ‘yes’? You will need to, as a minimum, have a small, private written agreement between the parties. It can be embarrassing to ask for an agreement. If the borrower is genuine, they will see the value in an agreement.
Loan or gift?
The first thing you need to decide is whether the money is a gift or a loan. Is the money being given with no expectation of being repaid? Then for practical purposes, it’s a gift.
Understanding the nature of the financial assistance from the outset avoids a misunderstanding that could divide the family.
While it’s considered a gift, for the purpose of asset protection, it is best to document the gift as a loan.
The potential problem with a gift is that it becomes part of your child’s assets. In the event of divorce, bankruptcy or the premature death of your child, that well-meaning gift to your child could end up in the hands of an unwanted party.
Whereas, if the assistance is properly documented as a loan, then at least you have a chance of recovering the family funds…by calling in the loan. While you do not expect repayment, the purpose of the loan document is to protect your family wealth from unforeseen circumstances. An ounce of prevention is worth a pound of cure.
The repayment of the loan can be forgiven in your estate planning, with a statement such as: ‘Upon my death, the loan of [insert loan amount] to [insert family member’s name] is forgiven.’ This can be inserted in your last will and testament. If you do forgive the debt on your death, it’s imperative this is accounted for in the distribution of the estate, and that other beneficiaries are compensated accordingly. Otherwise, you run the risk of unfairly favouring one over the others.
‘Sponging’ Son wins $280K Suit
The above article is a good example of what can happen to someone who lends money to family or friends. You most likely not have seen this article. However, there are many such cases occurring every day.
‘A son who “shamelessly sponged” off his elderly parents who lent him and his struggling business more than $280,000 will never have to pay them back despite being taken to court.’ How could you do that to your parents?
The judge declared that the son, in saying each time that he would pay his parents back in full. indicated a moral obligation but not a binding agreement.
Don’t let this be you!! If you have a written agreement, you have a prayer. If you have an oral agreement, you’ve just got thin air!
Prepare a basic agreement so that neither party forgets what they agreed to. If you need help, we can assist.