6 questions to ask when a relative asks for a loan

By Marianne Curphey

The recession has made it difficult for those with imperfect credit to get credit cards or borrow money from lenders. Many, therefore, are turning to another source -- family.

Inter-family lending is on the rise in the wake of the credit crunch, according to insurance and investment company Aviva. In August 2011, it found that lending between family members increased 63% in recent years. Moreover, the average amount owed to friends and family was significantly higher than that owed on overdrafts and credit cards.

The majority (61%) of those surveyed by Aviva said they liked the idea that people are increasingly comfortable turning to family for financial help. Yet lending money to a relative in need can strain your budget and your relationship. Before extending a financial lifeline to a loved one, ask yourself these questions:

1. Do they actually need the money -- or could they wait and save up themselves?
You may feel obliged to help a loved one out. But first ask whether they can -- and should -- help themselves.

In fact, one of the biggest flashpoints between parents and children, according to June 2012 research by Halifax, is that parents feel aggrieved that young people are not prioritising savings and are instead spending the money they earn. The bank found that 79% of parents believed the younger generation should go on fewer or cheaper holidays. Seventy-seven percent said the younger generation should cut down on going out in order to save for a deposit. family-loan

Before pushing your own budget to its limits to help out, think about what the money is needed for. If it is for a new car or a holiday, the person asking for a hand-out might be better waiting and learning to create a savings account.

2. What are the emotional implications of lending to a friend or family member?
Don't fool yourself into thinking that money has no emotional charge -- you will still have expectations about how it is going to be used and when it should be paid back, and your friend or relative may not agree.

The emotional fallout of lending money can change, depending on the relationship. A parent lending a child money, for example, is different from a sibling lending money to another sibling. Alvin Hall, financial broadcaster and author of You and Your Money has the following rules for preserving family harmony:

  • If you lend money to a relative do it without expecting to be repaid or to receive anything else in return.

    "If you can't lend on this basis, then don't lend at all," he writes in You and Your Money. "Lending money within a family is emotionally dangerous. It can lead to discomfort, anxiety and resentment on both sides, perhaps to extent of destroying your relationship" writes Hall.
  • If you borrow money, pay it back in full as quickly as possible.
  • Try always to treat siblings as siblings, not as parents or children. In other words, don't take responsibility for a sibling's life in the same way that a parent would.

3. Can you really afford to lend the money?
Halifax found that more than a third (38%) of parents have made financial contributions to help their offspring get on the property ladder. The total amount they've lent has increased by 31% in the past five years to reach nearly £13,000. That is a substantial sum.

Paul Crayston, spokesman for the debt advice service National Debtline, says that some of those who use the service are struggling with debt problems because they lent money to family members even though they couldn't really afford to do so.

"It is really important to think about whether you can cope financially before you are repaid," Crayston says. "You have to assume that you won't be repaid. What impact would that have on your finances?"

Before lending, look at your outgoings and check that you have enough money to pay for your own daily expenses, assuming that you'll never be repaid.

4. If relatives are turning to you for money, does this mean they'll struggle to pay you back?
While helping out with a house deposit or university fees can be anticipated and planned for, if loved ones are coming to you for short-term loans or help with everyday expenses, it could be a sign they need debt advice. There may be a good reason why they have exhausted all other avenues of credit -- because their credit ratings are poor due to unpaid debts.

Crayston says that it can be difficult to ask probing questions of the finances of the person you are lending to, but you need to establish whether they have any means of repaying the debt.

"Find out if they have a plan to make repayments and how much and how often they are going to pay you," he says.

5. Is it a loan - or is a really a gift they are embarrassed to ask for?
Be clear about the terms on which you are lending the money. Philip Pearson, an independent financial adviser with the firm P&P Invest based in Southampton, says that you need to decide whether the money you are giving is a loan or a gift.

"If it is a loan then it needs to be repaid -- a gift does not. There is a clear difference," he says.

It is when there are misunderstandings that disagreements start. --Philip Pearson
P&P Invest

 

If you do decide it's a loan, Pearson recommends setting out the terms in a formal agreement. Make sure both parties agree how much you are going to lend, over what period, whether you are going to charge interest and whether you will require regular instalments.

"Lending to friends or family can work if everyone understands what is agreed and what they are signing up to," Pearson says. "It is when there are misunderstandings that disagreements start."

Make sure that you and the borrower sign the contract in front of independent witnesses and that you both keep a copy. For large amounts, you may need legal advice.

"A written contract means that you have a record and you are able to chase debts as another creditor would," Crayston says. "Bear in mind that if the person declares themselves bankrupt then you probably won't get the full amount back."

On the other hand, if the money is a gift, and it is more than the £3,000 annual gift allowance, study up on the tax implications. If you die less than seven years after making the gift, it could be included as part of your estate and be subject to inheritance taxes.

6. What happens if you don't get your money back?
Simply asking for your money back doesn't mean you'll get it.

"Often parents lend money towards a house deposit," Pearson says. "And if there is a disagreement or you want your money back, will you be able to access that cash if it is tied up in a house?"

If there's a delay in you getting paid back, consider charging interest. If you don't, you are losing what you would have earned by having the money in savings. By asking for the equivalent of what the money would accrue in a savings account, you're still being plenty generous, as this will still be less than the cost of borrowing on credit card or on a bank loan.

However, the best strategy to make sure you're repaid might be a pre-emptive one: Have the borrower set up regular automatic payments to your bank account. Still, if the borrow has no money, automatic payment will be little help. If the loan was for less than £5,000 you may be able to make a claim for the money via the small claims court, but if it was larger you may need legal advice.

See related: How to make your children financially independent, Parents do more harm than good by shouldering children's debt

Published: 27 September 2012