Family loans won’t ruin relationships if you do them right.
There’s good, bad, and ugly debt. Borrowing for an education or a home is good debt, because you’ve got something to show for it and the asset will appreciate. Bad debt is credit card or credit line debt when you don’t know where the money went. Family debt, all too frequently, turns into ugly debt.
But sometimes, when all else fails, the family is the only source of necessary funds. Here are four ways to make it work.
Put It On Paper
Time passes, and even with the best of intentions people can forget or be confused about the terms of the loan. That won’t happen if it’s written up, signed, dated and a copy given to all parties. Repayment problems can still arise, but at least the borrowing conditions will be indisputable.
Most family loans are interest-free, but, especially for young adults who may be first time borrowers, charging a small amount of interest teaches them what borrowing is all about.
A major irritant with family loans is when the money is borrowed for one purpose and then used for something else. For instance, if you loan money to a sibling so they can buy a car for work or purchase clothes for a new job, but instead they go on an expensive vacation, it will create bad feelings between the two of you.
Include the loan’s purpose right in the lending document. You probably can’t prevent the borrower from blowing the dough, but it keeps things clear.
If you are contemplating lending money to a family member for a particular purpose and you’re concerned the funds might get frittered away, bypass the borrower.
For example, if your grandchild needs braces, offer to pay for them directly. There may be some accusations about you being over-controlling. Stand your ground. It’s your money.