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Loans To Family & Friends - What to Do

Over the course of a year we speak to many dentists about their financial affairs. Conversations take in all facets of their business and personal circumstances. Our advice is tailored to the individual and arrived at through logical and methodical best practice.

There is one topic that comes up frequently that invariably throws all the conventions of managing financial affairs out the window - loaning money to family or friends.

I have been in this situation and see it regularly with my generation seeming to cop the financial responsibility for both our parents as well as our children. Someone mentioned to me it has gone further with grandchildren now on the horizon!

I read an article recently in the Australian Daily Telegraph that summed it up very well and acknowledge a lot of the following is borrowed from that article.

There are two scenarios where family or friends ask to borrow money - the first is the casual $20 or $50 over lunch or at the pub. We usually don't give this a second thought and hand it over with the expectation it will be repaid or the favour returned in the future. Although I've notice with my children this doesn't appear to happen - but I digress.

The second scenario is where it is serious money - to purchase a car, start a business or a deposit on a house. Saying "No" can have serious consequences for your relationship and this is where the practical approach to managing financial affairs flies out the window as emotional factors kick in.

Before giving a response it may well be worthwhile asking a number of tough questions.

Can you afford it?

The assumption from the person asking is you have the wherewithal. Sometimes outward signs of financial wealth are based on a mountain of debt. So the first thing is can you afford to lend the money. More importantly can you afford to lose the money if things go wrong? You need to balance loyalty with your own financial stability.

What is the fallout of saying no?

Financial tensions can destroy families or friendships. What are the consequences if the loan goes bad or you refuse to lend? It is important to go through with the borrower all the reasons money is not available or, if it is available, what are your expectations for it to be repaid and the adjustments you expect them to make in their lifestyle to ensure it happens. Having a third party witness the transaction as an independent arbiter may be a good idea.

Is there a chance the money won't be repaid?

Assess the character of the borrower and whether they will stick to their promises

Are they reliable in other areas of their life?

Are they hard workers do they have pride in their achievements? These are good signs. On the other hand if they are unreliable or always looking for the easy way out then they are best avoided.

Why couldn't they borrow from a bank?

Banks are an easy scapegoat to blame if a loan application is rejected. Often the bank is the only one thinking with their head and not their heart. The bank will carefully assess a loan application looking at the purpose and the borrower's chances of repaying. If the bank doesn't think your friend or relative is a good risk for a loan why would you?

Are there alternatives?

If the borrower hasn't gone to the traditional lending institutions then suggest they take this route first and come back if rejected. Maybe assist with the application to improve their chances or provide a character reference. If they get the loan you are off the hook. If they don't get the loan then maybe they need to reassess the need for the money and whether the whole project is too risky.

Is there an alternative "non financial" option?

Can you help develop a plan or budget to cut down costs or ways to earn extra money to raise the money themselves? It is always easier to hit someone else up for money than to make sacrifices.

If they accept the offer that may be a good sign they are committed to making it work and assures you they won't be living the high life on your money. If they don't accept, then it's time to worry - maybe offer to make an appointment with a financial planner or accountant to get some independent advice.

What is the best plan for repayment?

If you decide to go ahead with the loan, then act like a bank. Make sure you have a repayment plan in place. Put it all in writing and depending on the amount you might even asking for security over a house or other assets - just like a bank would.

If the borrower is surprised by the formalities, tell them it shouldn't bother them if they're confident of living up to their promises.

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