I recently heard some advice from financial guru Suze Orman about lending money to friends and family [1]. Her basic view is that you need to have all of your own financial ducks in a row (8 month emergency fund, fully funded retirement account [2], fully funded 529 plans, secure job, able to easily pay rent/mortgage, etc.) before even thinking about doing so. And then, you shouldn’t lend the money at all; you should just give it [3] to the person with no expectation of being paid back. Why is this? According to Suze, the person asking for the money will likely never be in a position to pay you back and this could cause a lot of hurt feelings between you and the borrower. If you do decide to loan money instead of giving it away, make sure you won’t be “upset†or in financial peril if you do not get it back. Also, you should write up a promissory note so that in the event you are not paid back, you can write it off as bad debt [4] on your income taxes. The person you lent the money to will then be taxed on this money.
Honestly, I don’t know that I agree with all of Suze’s advice. Let’s take a look at my own past experiences with money borrowing and lending and then I will discuss my own opinions further.
My Own Borrowing History and Two Important Lessons Learned
Full disclosure: I borrowed money twice from family and friends while in college. Some of my best financial lessons were learned this way. In my third year of college I was ready to make my dream of studying abroad [5] in Japan a reality. The only problem? I did not have all of the money that I needed. I scored a scholarship from my International Studies department and had accumulated some savings from my federal work study job. However, I still came up short. And I did not just come up a little short; I needed a cosigner for a loan to cover the rest of tuition at the school in Tokyo, as well as some cash for living expenses.
Borrowing Money from Friends. Looking back on this now I see how badly everything could have turned out, as my boyfriend-at-the-time’s mother offered to cosign the loan for me. I paid off the cosigned loan within two years of returning from Japan. From time to time, I reflect on how lucky I was that this woman had put so much faith in me—it truly was a generous and bold offer on her part. Just reading this scenario I am sure you see the potential for disaster. She must have heaved a huge sigh of relief on the day she got the letter saying that the loan obligation had been fulfilled.
- Lesson Learned: When people put their neck on the line for you, you should do everything possible to make them not regret that decision.
Borrowing Money from Family. For the living expenses, I received a loan from my grandfather. While I diligently paid on the cosigned loan, I dragged my feet paying my grandfather back. I had promised him that I would send what I could each month from my federal work study job once returning from Japan. And I did. For the first 4-5 months I sent him $100 per month. Then, I started investing in my relationship with my boyfriend whom I met in Japan instead (now my husband!) by saving up most of my money to fly and see him every six months or so. Tickets to Japan are very expensive. I rationalized that I would certainly pay my Pop-pop back when I got my first job out of college (about a year away), and that surely he would not expect a college student to pay back the loan while in college.
One day, my father called me to say that my grandfather thought it was very interesting how I could manage to fly to Japan but not manage to pay him back. I was pretty mortified, as my grandfather was completely correct. The money I was spending on my own life was really not my own; it was my grandfather’s money. I had given him an oral contract for how I would pay it back, and I was not living up to my side of the deal. Within a week I sent my grandfather a $1,000 check and an apology. I began consistently sending monthly payments after that.
- Lesson Learned: When you owe someone else money and you choose to spend your earned money on luxuries and entertainment, you are really spending their money and they will probably be upset about it (for good reason).
A Recent Lending Experience
Lending Money to Friends. Since learning those lessons several years ago my husband and I loaned a friend some money. It was a weird incident where money was needed almost immediately to rectify the problem. While I would not like to go into the specifics of it, suffice it to say that we have not been paid back any of the money in over a year and a half. This friend did not have much money to begin with but had promised to pay us back on his next paycheck. This turned into his next paycheck after that, which turned into his tax return [6], and then he lost his job [7].
We have asked to be paid back and he understands the expectation of this loan. However, we have not been persistent with him partly because we realize his financial situation is not great and that he probably has many more financial concerns than paying us back. But the nagging question I have had in my head is: why couldn’t he afford to send us $10 each paycheck while he was employed? It’s not the money that is upsetting me as much as the fact that he never made a good faith attempt to right the situation. He is a smoker, and I can’t help but feel a little like how my grandfather felt with me. If he can spend a hundred dollars or so on his cigarette habit [8] each month, then he can certainly make an attempt to pay us back. Heck, we never even received a thank you note.
My Thoughts on Suze’s Lending Rules
I have to admit that even after being on the lending side of the equation [9] I do not naturally agree with some of Suze’s opinions on lending money. For example, what if a family member was on the street and needed money for food and clothing? I would hope that if my emergency fund was 3 months instead of 8 I would still gladly give money to them and offer up a spare bedroom. And why shouldn’t I expect to be paid back if those were the terms of the request in the first place? True, my stubbornness on this point could decay a relationship, which is sad indeed. But the idea that I could just freely give money with no expectation in return and without feeling a little like “wow, they can afford fill in the blank but they couldn’t afford to pay me back?†is a bit of a fantasy. Perhaps this is because I am not a wealthy individual. Maybe if I had more money then giving it away to friends and family members with no expectation for return would come more naturally to me (though I do suspect that wealthy people do not become so by giving money away with no expectations of repayment). Perhaps this trait will come as I age. But for now, I don’t think that it is a natural thing to do.
I do love her suggestion about the promissory note, and had no idea that it could be written off as bad debt [4]. Then again, I wonder if the person was not able to pay me back, then how could they afford to pay the taxes on the money they borrowed?
Have you ever borrowed money from family or friends, or have you ever lent money to people close in your life? What was the outcome? How do you feel about Suze’s rules on lending?