Lending Money to Friends: How to Ensure Good Karma, Not Bad Blood

A tale of two loans and two friendships: Guiliano Stiglitz, an executive who lives in Miami and London, says he has never had any resentment over money he loaned to a friend, even as much as $200. "I write it off immediately," he says. "If they return the money, it is a pleasant surprise. If they don't, well, I already knew."

But Vivian P., a textile designer in New York City, felt differently about the $300 she loaned to a friend who needed it to pay her rent. Vivian's resentment flared when the loan went unrepaid, and the friend regaled her with shopping stories. "Soon after, I was desperate for money, pregnant, and terrified. I was confiding in her as a friend," she recalls. "I remembered I lent her the money, and she was convinced we had made a deal where I said she didn't have to pay me back."

A Sensitive Subject

Lending money to friends and family ranks among the most pernicious of relationship stressors. An unrepaid $100 here or there may only engender bad blood (or a write-off), but what about $8,000 for a new car? Or $10,000 to pay tuition? With thousands of dollars on the line, no karma is worse than that carried by unpaid debt.

Informal loans -- whether between parent and child or two strangers making deal -- can be as low-key as a back-of-a-napkin or handshake agreement. While such deals can and do stand up in court (provided there is sufficient evidence to prove the loan was made), the promissory is vague. Add in confusion regarding payment deadlines and naturally lax record keeping, and such loans are a recipe for resentment.

Dr. Maggie Baker, a psychologist and author of Crazy About Money, says that money lending between friends and relatives raises a number of emotionally sensitive issues. First, talking about money -- as in how much you do or don't have -- is often taboo. Add to that the complicated feelings about money we've all gleaned from our environments, and layer in the sensitivity of a personal relationship.

"Most people think 'I'll never get it back', and that, I think, is terribly wrong because it is symptomatic that people can't talk about money," she says.

Informal Lending is Big Business

Nearly a quarter of Americans turn to friends and family when they find themselves having financial problems related to debt, according to a 2011 survey by the National Foundation for Credit Counseling. While figures for how much money is actually swapped through informal channels are hard to find, some estimates place it at $3 billion or more a year.

Sponsored Links

It's possible to help out a friend in a responsible, fiscally sound way, provided that certain measures are in place -- among them, a solid loan agreement. LendingKarma.com provides a streamlined way to track, document and manage loans. Started in 2009, the start-up has been used to formalize $60 million in person-to-person loans. The site supports loans with easy-to-use origination documents as well ways to collateralize a loan, send email payment alerts, and track payments.

Founder and CEO Michael Kovacs started LendingKarma after college, when he needed cash for a car. He looked to his family for the money. "I needed a loan, not a gift," he says.

"For most people, asking for a loan is not fun. It's confusing and intimidating." The purpose of the website is to remove that intimidation factor and make the process approachable.

Kovac says the fee to create a loan on LendingKarma -- from $15 to $60 -- is a small price to pay "to take things seriously." With an average loan size of $50,000, LendingKarma users appear to take things seriously indeed. The majority of loans are for cars, education and bill consolidation, says Kovacs, though he has seen increasing activity in the arena of home down payment loans.

[Calculate loan payments.]

What Are You Really Borrowing?

Baker says another sensitive issue that arises when borrowing or lending money is the change in status between family members or friends that comes with exchanging funds. Where once you may have been equals or had established roles, the loan puts the lender at the top of the totem pole, and the borrower on the bottom.

"The potential loss is not only of the money," says Baker. "In a family situation, there may also be a change in relationship."

To address those issues, Baker advocates for a direct approach. Lay it all out: How much is being borrowed? How long will repayment take? How does it affect the relationship? "Get it right out front," she says. "You learn why they are really asking for the money. It cuts down on the sense of urgency to do it immediately. Having a dialogue with the other person could make it clear what real situation is."

In the end, the Bank of Friends and Family is often the lender of first -- and last -- resort. To keep the relationship stress-free, both Kovacs and Baker emphasize the importance of putting things into writing.

"Even if the loan goes bad, a properly documented loan can at least afford the lender a potential tax write-off," says Kovacs.

Five Tips For Loans with Friends and Family

1. Decide whether it is a loan or a gift. "If it's a loan, treat it seriously. Half measures are often the cause of great misunderstandings, and we have the tools to help people succeed," says Kovacs of LendingKarma. "A minimal upfront effort and cost will save lots of pain -- and relationships -- later."

2. Put it in writing. Whether you take a formal approach with an online service like LendingKarma, or write things down on a piece of paper, make sure to include the loan basics: the amount of the loan, interest rate, repayment schedule, collateral if necessary, and have both parties sign it. Blank contracts that are valid under individual states' laws are also available online.

3. Don't lend more than you are prepared to lose. Even the most well-intentioned borrowers can default on a loan. For lenders, that risk can be secured with collateral (like a car or other item). Otherwise, be prepared to take the loss. If you have the loan properly documented, you can write off the loss on your taxes.

4. Ask the borrower to look for other sources for money. If you feel strongly about not risking your relationship over money, Baker recommends looking at all the alternatives. A bank or alternative source of funds can reduce the feelings of all-or-nothing when a relative asks to borrow money.

5. If you're negotiating terms of the loan, bring in another person. Whether you feel you are being strong-armed into loaning money or the emotions are heating up, bringing in a neutral third party can help defuse the intensity of the conversation.

[More tips are available from the National Foundation for Credit Counseling.]

Catherine New is a reporter for DailyFinance.com and Aol Huffington Post.