Lending money to a loved one: 10 tips to guide you

With the rising cost of living, increasing interest rates, and what is now known as “generational inequity,” it is becoming more common to hear about parents financially assisting their children. Whether it’s for the purchase of a first home or a small personal loan, this help can sometimes seem inevitable.

In Quebec, many parents have benefited during the past decade from the growth in real estate values, generous pension funds, a dynamic job market, or stock market investments. This context has led some siblings to seek financial help. Faced with this delicate situation, how can you make a wise financial decision while making sure that the family or friendship bonds are not put at risk?

Here are 10 tips to guide you in deciding whether or not to lend money to a loved one:

1. Determine what the money will be used for.
2. .Assess the borrower’s financial situation.
3. Consider your own financial situation.
4. Require your borrower to create a budget.
5. Set repayment terms before making the loan.
6. Consider charging interest.
7. Be aware of the risks to your relationship,
8. Put everything in writing.
9. Obtain collateral or a guarantor.
10. Be aware that a debt can become statute barred.

Let’s now look at each of these guidelines to help you decide whether or not to lend money to a loved one:

1. Determine what the money will be used for
   In our daily lives, we have the freedom to do what we want with our money. However, when financial assistance is needed, it is legitimate for the lender to want to know what the funds will be used for. There is a big difference between paying off a new partner’s debts and financing urgent roof repairs.
2. Assess the borrower’s financial situation 
   This step is crucial and delicate. It requires a great deal of transparency from the borrower and may give the lender a sense of being intrusive. Yet, it is essential to know the borrower’s debts, assets, and budget to ensure that the financial help is being used effectively. A loan intended to pay off a $2,000 debt when the person owes $20,000 to other creditors may only be a band-aid on an open wound.
   
   Also, taking into account the borrower’s assets and knowing if they are fully paid for can help ensure the real needs. For example, if the child owns a paid-off motorcycle and prefers to borrow $5,000 from you rather than sell the motorcycle, this could be a sign that they are not ready to make sacrifices to get out of their financial predicament.
3. Consider your own financial situation
   Lending money that you have and won’t need in the short term and lending money that you would have to borrow are two entirely different circumstances.

   Too often, parents, out of embarrassment or concern about admitting a lack of resources, agree to lend to their children. However, in doing so, they risk putting themselves in a precarious financial situation. In most cases, the borrower would not have asked for help if they would have known it would put their parents in difficulty. Ensure that your decision to lend doesn’t place you in a precarious situation. Prioritize your own financial health before committing to financial assistance for someone else.

4. Require a budget from your borrower 
   To effectively help a loved one, the request for money can be an ideal opportunity to help them put some order in their finances. The key to sound financial management is a well-thought out and time-tested budget. Does your loved one know how much they earn each month and, more importantly, how much they spend? A deficit budget is often at the root of financial problems. When a budget is in deficit, access to credit becomes an easy solution to cover the shortfall, but this credit comes at a cost. Each additional loan increases expenses and worsens the monthly deficit. This is how more than 40% of people who consult us end up, after several years, with debts of $30,000 or more on their credit cards and lines of credit.
5. Set repayment terms before making the loan
   Discuss repayment terms before lending money. Insist on monthly repayments rather than a vague promise to reimburse the loan, for example after receiving a bonus or vacation pay. These are often unreliable as other financial needs frequently arise along the way, leading to delays in repayment. In contrast, monthly payments allow the borrower to adapt to a new budgetary reality. The sooner they start repaying, the quicker they will learn to live without the borrowed money, which will help them adjust their spending to their actual resources.
6. Consider charging interest
   Requiring that interest be paid might make you uncomfortable, but it has several advantages. If the money lent comes from an investment, it compensates for the potential loss of return if you lend money that you could have invested elsewhere. Additionally, charging interest can encourage the borrower to repay more quickly and help them understand that credit is never free, even when granted by a loved one.
7. Be aware of the risks to your relationship
   Lending money to a loved one introduces a creditor-borrower dynamic that can complicate relationships. Establishing clear rules in advance, such as not purchasing certain items or limiting travel before full repayment, can help avoid these possible conflicts. As in many areas of life, managing expectations is key to maintaining a healthy relationship.
8. Put everything in writing
   Regardless of the family relationship, it is essential to formalize the loan in writing. This document should specify that it is a loan, the repayment conditions, and, if applicable, the interest rate. This facilitates loan management and can serve as evidence in the event of a consumer proposal, bankruptcy, or dispute. To avoid such complications, you might consider consulting a legal advisor, especially if the amounts involved are significant.
   
   For the same reasons, it is better to issue the loan by check or electronically rather than in cash. If you hand over cash and the borrower decides to use it without depositing it into his/her bank account, it could be harder to prove the existence of the loan in case of bankruptcy or dispute.
9. Obtain collateral security or a guarantor
   For large loans, obtaining collateral can offer additional protection. This may include a mortgage on an asset such as a vehicle or home; it assures that you would be paid in priority in case of insolvency or non-repayment. A guarantor involves having another person guarantee the repayment of the loan if the borrower defaults.
10. Be aware that a debt can become statute barred
    Debts can sometimes become legally impossible to collect simply because time passes without any activity (i.e., payments, debt acknowledgment, etc.). This is known as “prescription,” and it can occur after just three years of inactivity. It is important to be aware of the consequences and you may consider consulting a lawyer or notary to avoid surprises.

Finally, in our experience, situations of non-repayment rarely result from a lack of will on the borrower’s part. In most cases, it is more the result of financial incapacity. Therefore, when deciding to lend money, it is crucial to make a rational decision and not be influenced by the idea that “my son or daughter would never put me in trouble.”

We understand that this decision involves important personal considerations such as family, mutual aid, and pride. These tips are not intended to help you make a final decision but rather to raise awareness of potential pitfalls. An honest and open discussion with the borrower is essential to limit the risks of future tensions, disputes and dire financial consequences.

For any questions or advice, please do not hesitate to contact us.

By Pierre Fortin
Jean Fortin & Associés
Personal Finance Advisor
Licensed Insolvency Trustee