Is Lending Money to Relatives a Good Idea?

There's no doubt, lending money to relatives is a highly controversial issue. Mary Jacobson loaned her son $20,000 toward the purchase of a new RV. Three years later, the money is all paid back with interest, and Mary enjoys several excursions each summer with her son and daughter-in-law.

Ray Pembroke, on the other hand, loaned his younger brother $10,000 to start a printing business. Nine months later the business folded. After five years, Ray has collected less than half of his money, causing great strain in their relationship.

Those who have been burned can rant and rave for hours about their folly. But there are numerous others who have loaned money, been paid back in a timely manner and made a fair interest rate. Everyone agrees however, the decision whether or not to loan money to a family member is especially tough.

Any lending includes some amount of risk, yet at the same time we all want to believe our loved ones are totally honest, above-board individuals. You should ask yourself: is this person responsible? Do they have a proven track record in their other financial dealings or did they come to you because no one else was willing to loan them money? If this is the case, think long and hard before saying yes.

It's very important to consider the consequences if your relative defaults. How will you handle the situation? Could you (or would you) bring legal action against your own son, daughter, sister or beloved Auntie Lou? Can you live without the money, should the worst happen? What will happen to your relationship in the long term?

If you choose to make such a loan, treat the entire arrangement as business-like as possible, by drawing up a formal note. Even if you trust your relative one hundred percent, people do die accidentally or become disabled, so you need this documentation to protect both sides. You can find sample legal forms at most banks, office supply stores or online. If the amount is large, consider hiring an attorney to draw up this paperwork. In addition, should your relative default, you'll need an enforceable loan document to deduct the loss on your income tax.