How would you like to have a $500,000 loan outstanding and be in doubt about ever getting it back? Add in the fact that family members are involved and you have a recipe for financial and relationship disaster.
This is exactly what is facing a couple who wrote to me last week. The loan in question was to their daughter and son-in-law to buy a home.
Recently the daughter quit work to become a stay -at-home-mom. As a result, they can’t afford the loan payments and want to “renegotiate.”
Just imagine the acrimony that this loan has birthed. Mom and dad need the income from the loan. The kids are looking for payment relief. Mess.
Many financial experts counsel against lending money to kids, parents or siblings. In a perfect world, I would agree. However, deserving people often can’t get loans for legitimate purposes.
Perhaps they have a short credit history, are self-employed or have experienced job loss or illness.
I won’t tell you not to lend money to family members, but keep it businesslike. You will be doing everyone concerned a favour. Here are some guidelines:
1. Know the reason. As the lender you have the right to ask about the purpose of the loan. If you are uncomfortable with where the money is going, keep it in your wallet.
2. Assess affordability. The borrower should draw up a budget proving they can make payments. The lender must ensure they can afford to lend the money and do without the income if the borrower defaults.
3. Put it on paper. A signed agreement should detail principal, interest, payments and the term. For a house purchase, have a legal mortgage drawn up which gives you recourse if payments aren’t made.
4. Get post-dated cheques or set up a separate bank account with an automatic transfer of payments from the borrower. None of this protects you from a family loan gone wrong, but at least you’ll have done your best to ensure both sides are clear about the terms.