Should I loan money to friends or family?

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Anyone who has ever loaned money to a friend or family member is likely going to tell you to never do it. No matter how you go about doing it, a loan between friends or family always seems to end badly.

Consider my personal experience with this issue: Friends were desperate for money and I contemplated whether or not I could help. We had discussed money issues in the past, and had agreed that as long as financial transactions were treated "as business" and as long as all parties were honest, money wouldn't come between a friendship.

I loaned my friends the money they needed with a loan agreement laying out the payment terms. When the time came to pay, they didn't pay. We discussed new payment terms, and a new loan agreement was drawn up to reflect the new terms. And again they didn't pay.
By this time I was upset, because both the husband and wife had become employed and had decent paychecks. They had the ability to pay me just as we had agreed. Why weren't they paying back what they promised to pay? Simply put, it's because they were dishonest and never intended to pay me back. They took my "free money" and thought they deserved to keep it, just because.

Should I have just chalked it up to a "gift" and moved on? I don't think so. If I meant it to be a gift, I would have given it as a gift from the start. I wouldn't have gone through all the trouble of creating loan agreements to document what we'd worked out. I ended up having to take them to court to get my money back, and the friendship was over.

I only needed one experience like that to make me decide never to loan money to friends or family again. However, some people think you can do it successfully. SmartMoney.com offers some tips to make it "safer" to loan money to family. Included are things such as documenting the loan, setting an interest rate (rather than interest free), and deducting a bad loan on your taxes when your friend/family isn't going to pay you back.

I say all those suggestions are nice. And that money still comes between family and friends. You're better off saying that your money is "tied up in investments" or otherwise unavailable. Never let family or friends know that you have available cash. It's a disaster waiting to happen.

Tracy L. Coenen, CPA, MBA, CFE performs fraud examinations and financial investigations for her company Sequence Inc. Forensic Accounting, and is the author of Essentials of Corporate Fraud.
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