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Should you lend money to family and friends?

When your brother or best friend comes to you needing money, it may be better not to make a loan. But if you do, there are a few things to consider.

Should you lend money to family and friends?

Giving loans to family and friends is quite common, but

studies have shown that a high percentage of such loans are

not paid back and they can lead to disharmony. TODAY file photo

“Neither a borrower nor a lender be,” advised Lord Polonius in Shakespeare’s Hamlet.

When your brother or best friend comes to you needing money for something like healthcare or their children’s education, though, that advice can be difficult to follow.

Lending to family and friends is indeed quite common around the world. While data for Singapore is scarce, a study by payment system company Payleven in the United Kingdom in 2014 found more than half of the survey participants had lent friends and family an average of £272 (S$503) a year, and a quarter had argued with or lost a friend because of it.

PayPal’s Money Habits survey last year similarly found that more than one-third of adults in the United States had loaned an average of US$450 (S$609) to friends or family, and nearly 50 per cent were not paid back.

A key challenge with repayment, San Francisco State University associate professor Ryan Howell told PayPal, is that consumers are more willing to discuss their sex lives than their bank accounts because of deeply-entrenched social conventions around money, which cross borders and cultures.

The challenges are likely to be similar here in Singapore, and it may be better to not make a loan.

CONSIDER THE REQUEST

Despite the potential for not getting paid back and losing friends, it can still be difficult to say no. If you do feel you need to go ahead with the loan, it is important to get more information rather than lending money unconditionally. While money may be a taboo topic in many cases, it is perfectly appropriate to ask questions when a friend or relative asks for a loan.

A first step is asking how the money will be used. Loaning money for school fees or medical care, for instance, is very different from loaning money for a vacation.

It is also important to figure out whether and how they will pay you back. If a family member has borrowed before and not repaid, for example, lending money may not be a good idea.

You should ask how they plan to repay you, since they may also not have money in the future. You can ask whether they have considered alternatives such as loans from banks or even pawn shops.

If you do decide to make a loan, figure out how much you can afford to lose. While many loans are paid back, it is important to think about whether you can afford to lose the amount you lend.

One additional consideration is that the taxman says interest from loans to “persons” is taxable and needs to be declared in your tax form.

GETTING PAID BACK

If you do lend money to a friend or relative, it is important to maximise your chances of getting paid back, especially since lenders and borrowers often have different recollections about the loan.

The reason for that difference, research from Carnegie Mellon University professor George Loewenstein and University of Vienna researcher Linda Dezso showed, is that borrowers have “self-serving biases” such as believing that the loan had been repaid or that it was more of a gift than a loan.

They also found that overdue loans had wide-ranging negative repercussions, including lenders predicting they would never be paid and feeling less closeness to the borrower. “This research provides empirical backing for the many adages cautioning against lending to a friend: Lending can be hazardous to a relationship,” said Ms Dezso.

As an example of what this means in practice, Pew Research found that although 26 per cent of Americans said they made a loan to friends or family in the past year and it averaged US$1,000, only 12 per cent of Americans reported receiving a loan and they said they only borrowed US$560.

Even though it might seem nicer to be informal with friends, the research shows why it is better to formalise the loan, so that you can get paid back and minimise misunderstandings.

Most importantly, put everything in writing. It is better to have an agreement showing how much you are lending, the interest rate, a repayment schedule and other terms. You and your friend or relative should both sign the agreement. You can draft a simple agreement yourself or, especially if the amount is large, engage a lawyer to write it.

Once you have made the loan, good communication is essential. If the borrower is late in repaying the loan, you should find out why.

If the borrower cannot pay what they have agreed, consider renegotiating the repayment schedule or even the amount so that you at least get part of your money back.

If you do have difficulties getting paid back, legal information website SingaporeLegalAdvice advises engaging a lawyer to send a letter of demand or approaching a Community Legal Clinic to seek free legal advice. Community Mediation Centres may also be able to help with a solution.

While it may be better not to lend money to family or friends, understanding the reason for the loan and structuring it well can minimise misunderstanding and maximise repayment if you want to go ahead with it.

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