In these times of financial hardship, kids, siblings or even parents may ask for a little financial help to get by. However, when family ties supersede credit ratings, things get complicated fast. Ken Clark, the author of “The Complete Idiot’s Guide to Getting Out of Debt,” is a certified financial planner and a trained psychotherapist. “From both those ends, I would advise against it,” he says of loans to relatives. For family members who do choose to lend, Clark offers some advice and some caveats.

In these times of financial hardship, kids, siblings or even parents may ask for a little financial help to get by. However, when family ties supersede credit ratings, things get complicated fast. Ken Clark, the author of “The Complete Idiot’s Guide to Getting Out of Debt,” is a certified financial planner and a trained psychotherapist. “From both those ends, I would advise against it,” he says of loans to relatives. For family members who do choose to lend, Clark offers some advice and some caveats.


Q: What mistakes do people make when lending money to family?

The biggest mistake is not structuring the loan like any other loan. Usually, when family loans to family, the expectations for repayment never get clarified. If the borrower can repay the loan quickly, this doesn't present a problem. If the repayment drags on and on, it can become the elephant in the room between the borrower and the lender, as well as extended family members aligned with each person.


Q: Should you charge interest?

Charging interest ultimately helps both parties to walk away from family loans feeling good about the transaction. The borrower avoids feeling like a charity case, and may even feel like they did a family member a favor in markets with current lousy rates of return on alternative investments like money markets and CDs. The lender walks away feeling like, if nothing else, they were not taken advantage of by a family member.

Lending large sums of money at below-average interest rates could trigger some attention from the IRS. Make sure to consult your accountant before making any large loans.


 Q: How should such a transaction be structured?

Ultimately, the loan payments should be reasonable enough that the borrower doesn't default at the first minor setback. Instead, consider structuring the payments at no more than half of the borrower's discretionary income, or money remaining after fixed and necessary expenses. A simple typewritten loan agreement should be used and signed by both parties. As a general rule for lower-income borrowers, amounts under $1,000 should be paid back within a year, $1,000 to $5,000 in two to three years, and more than $5,000 in five years or longer.


Q: Are some debts or expenses more problematic than others when relatives borrow money?

Judging why they need money is critical to the lender. A child who needs help buying a car or house, or helping a responsible relative who lost a job is one thing. Loans used to simply meet monthly expenses are more likely to become a habit than those that are used to consolidate other debt or create some kind of change.

Loans that are not backed by some type of assets or collateral are always more problematic. If the loan is used to buy a home (or) car, that asset could be turned over and sold, should worse come to worse.


Q: When should you absolutely say no?
Most importantly, don’t lend money if the relationship is not strong enough to bear the frustration of not being repaid fast enough or at all. A loan isn’t helpful if it is going to damage the relationship. Also, avoid lending to someone with a poor borrowing track record, either with lenders or other individuals. In other words, we don't want to enable a serial borrower to continue robbing Peter to pay Paul. 

Finally, think twice if your spouse or partner is not clearly on board with the loan. This is the wrong time to pressure your significant other, since there will likely be some disappointment or frustration with the process.