How to Lend Money to Your Family Members

Whether it’s for an overdue bill or to fund a new business, a relative will ask for financial help at some point. Follow these tips for a smoother lending process.

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Loaning money is universally awkward—especially when it comes to family.

And a close relative asking for a little money on the side to tide him over is more common than you might think.

The National Foundation for Credit Counseling’s 2012 Consumer Financial Literacy Survey found that for 27% of Americans, friends and family members are the first resource they would turn to for help with ongoing debts.

And it’s not just for personal reasons that we request funds: According to a survey by the National Small Business Association, 19% of start-up companies reported tapping family members for a private loan to cover costs.

So how do you avoid becoming the family ATM? We talked to Katie Brewer, LearnVest Planning Services CFP®, and family therapist Retha Buck about the best way to deal with a loved one who constantly drains your finances…and how to get your money back.

1. Establish Which Type of Loan It Is

It’s important to be up-front from the beginning about the fact that your money is a loan, not a gift. Sometimes you loan money without necessarily expecting to see it again (like spotting someone for lunch), but there’s a difference between a $7 sandwich and a $300 car repair loan.

So, is this money a gift or a loan? If it’s a loan, put your agreement in writing. Make sure you know how the money will be used and the terms for repayment: How will it be paid back? In what increments? How long does the lender have to pay you? Aside from clarity, you’re putting your terms in writing in order to give yourself leverage: The document will allow you to take your family member to small claims court in pursuit of repayment, if need be.

“As awkward as it might be to ask your family member to sign on the dotted line, it protects both you and your relationship if you put it in writing,” explains Brewer. “It doesn’t necessarily have to be a formal contract, although that might scare your borrower into actually paying you back!”

Just signing the back of a flier will do the trick, but you can also use a resource like LendingKarma, which allows you to purchase a contract prepared by an attorney for $15 to $60 and tracks the progress of your repayment, or the $25 software program Family Lawyer.

2. Protect Yourself

A word of caution: When helping out a family member financially, make sure to guard your credit. “I run into people who have really good credit and get sucked into co-signing for a loan, or put their brother on their cell phone plan,” recounts Brewer. “Then their family members default and it messes up their credit.” She advises clients to steer clear of putting their own credit on the line to help a family member.

Also, if your loan is really big (think $11,000 or more), you could face tax implications, which is another reason to put your terms in writing. If the loan is smaller, it shouldn’t be an issue.

Of course, you’ll need an incentive to make sure you’re paid back.

It could be an interest charge, specified in your contract, or something as simple as a warning, issued in person and in writing: “If you don’t pay me back in full within the next two months, as agreed, this is the last time I’ll loan you money.”

The trick to the latter? You have to mean it. You could also consider taking collateral—for instance, if your uncle loves his fishing rod and needs to borrow $200, you can suggest holding onto that rod until the loan is repaid.