The New Year is always filled with hope and the possibility of our circumstances changing for the better, especially our finances.
While there are many ways to improve your finances in 2020, there is one aspect that can significantly improve both your finances and relationships; that is NOT lending money to friends and family!
I have been both a recipient of a loan from a family member, my sisters to be exact and the lender as well to some friends. Although there was never any timelines as to when I would return the money with my sisters, we have always trusted one another to do the right thing, and we have. On the other hand with friends, I have tried to limit lending to friends, but in the instance of doing so, my lending has always come with very strict conditions and terms of repayment.
So, why should you not lend money to family and friends, 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 this is the person you know and trust. You have to trust their ‘word for it’ and believe that they will repay the funds in full at the time they say they will.
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 both the lender and borrower feel very awkward to discuss an alternative.
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, add to the fact that the loan is interest-free; a loan to a family member or friend can take months, sometimes years to repay.
The terms and conditions of repayment are not clear
There are normally no terms of when and how you will receive your money back. The agreement is based on when your loved one is financially viable again, and this you cannot tell when will materialize.
And because there is no written agreement, the parties involved never discuss what recourse there is for non-payment. It is just assumed that they will pay back.
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. Your money should always be working for you by earning interest or by buying assets that will appreciate in the long-term.
Never cosign a loan with a friend or family member
Cosigning on a loan is not only reckless but you can find yourself in financial ruin because of a loved one. When you cosign a loan, you are severally and equally liable to pay not 50% of the loan, but 100% of the loan should your friend or family member not pay. Be sure you can afford to pay if you have to, and that you want to accept this responsibility
I reckon 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 them paying you back is very slim. You have to be ok with writing off the debt and still keep your relationship going.
It can be hard to say NO to a loved one approaching you for help, but sometimes, it is the best for your own finances and your relationships.
***This article first appeared in City Press
2020: Grow your Net Worth with My Money, My Lifestyle
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