The right way to loan money to family members

By Liz Pulliam Weston

With three words, you can sum up the most common advice about lending money to your relatives: "Don't do it."

Financial planners warn that intrafamily loans can lead to trashed relationships, shattered finances and even trouble with the IRS. People who've lent money to family members often complain about ingratitude, missed payments and strained holiday dinners. Even the borrowers grumble, especially when their benefactors start quizzing them about their spending.

"Suddenly, (the lender) is looking at the vacation they took and saying, 'They owe us money, how can they go on vacation?'" said financial planner Karen Ramsey, author of "Everything You Know About Money is Wrong." "The borrowers pick up on that judgment, and they get resentful."

Drawing up a contract

Yet still we lend. Why? The answer is contained in four words:

"They needed the money," said Sharon Conway, a Newburgh, N.Y., mother who, with her husband, lent $24,000 to their 30-something daughter and her husband. "They really got themselves into some debt, and they asked for help."

But the Conways' experience -- at least so far -- shows family loans don't necessarily have to be an unmitigated disaster.

The Conways hired Virgin Money US, based in Waltham, Mass., to administer the loan. After deciding on the terms -- "the kids insisted on paying interest," Conway said -- Virgin Money US drew up the contract for a five-year loan at 4% interest and arranged to have the monthly payments whisked from the kids' checking account to the Conways'. The cost for this service: a $199 one-time fee, plus $9 a month. Given the monthly cost, it would be uneconomical to do this for loans where the monthly payment amount was small.

"We didn't want to be the cops when the loan was due," Conway said. "Now, the money comes like clockwork."

Daughter Terri Garrison said she's grateful her parents were willing to help, since some of the debt she and her husband, Christopher, had accumulated was piling up interest at rates in excess of 20%. Garrison also agreed with the Conways' assertion that the younger couple treats the loan more seriously than they might have otherwise because a third party is involved.

"Money gets tight and you think about wanting to skip a payment," Garrison said, "but the payment comes directly out of our checking account."

$300 billion in informal loans

Virgin Money US also allows loan payments to be reported to the Equifax credit bureau to help borrowers build their credit rating.

Virgin Money US is, in effect, formalizing the world of "informal loans" between family members and friends, said CEO Asheesh Advani.

A former employee of the World Bank, Advani said he saw how such transfers help people worldwide buy homes and start businesses. In fact, the World Bank says informal loans and gifts between family members, friends and employers total more than $300 billion and account for up to 41% of household income in some Third World countries.

Of course, you don't need to hire a company to help you set up a family loan. And we'll leave aside the question of whether such lending in the industrialized world is "good" for either side. I trod that particular ground in "Should you bail out spendthrift parents?".

Continued: Don't lend it if you can't afford to lose it

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