How I Learned To Lend Money To Family & Like It

October 13, 2017

In traditional financial planning circles, lending money to family is considered taboo. However, I must admit, I’ve bent the family finance rules a few times. Please don’t judge. After making some big mistakes (that you don’t have to make because you are wisely reading this blog), it’s actually worked out well for everyone. Here’s what happened.

Lending to family the first time: 3 big mistakes

A close relative of mine who had been living with me in the Rocky Mountains found a job opportunity in Las Vegas that was exactly what she needed to get her foot in the door. All she needed was a reliable car to get there and then to use while living there. Since she had no money, I agreed to sell her one of mine at less than market (because she is family) and we agreed she would make payments to me once she got settled.

Saying good-bye to my Trooper

So, that’s how my perfectly maintained, excellent condition 1992 Isuzu Trooper was soon never to be seen again. Long conclusion short – things hadn’t gone according to plan and my family member didn’t want me to know that the job hadn’t panned out the way she’d hoped. She had sold that awesome SUV for an absurdly low price to raise cash, keep her place, and continue her job search. She couldn’t bear to tell me and kept hoping she’d get a job and be able to start paying me back without my noticing too soon.

When I finally did find out, I felt soooo foolish. Every older person I knew had warned me never to lend to family or friends. I learned some valuable lessons:

Mistake #1 – Not assigning market value. The market is the market when it comes to anything, and if you end up with an asset for whatever reason, you want to make sure you’re not devaluing for no good reason. (even if it is family)

Lesson: Assign a realistic value to things.

Mistake #2 – Not formalizing the agreement. There’s a stereotype about rural folks whether they be from the mountains or the plains: Your handshake is as good as your word. While I’ll admit the stereotype is completely true (it’s still dangerous to go back on a handshake deal), you may be surprised to know that even where it’s recognized as official, it’s just a place holder until something formal is put in place. Without something in writing, the terms of any loan can get fuzzy and someone or everyone gets hurt.

Lesson: Put it in writing. As my father always said, “When you trust each other, neither of you has any problem putting it in writing.” When it comes to family, the formal agreement is arguably even more important than in traditional business. The repercussions are very long, after all.

Agree to sign a Promissory Note with your borrower (you can get a template online for free) and set up a payment schedule in the document. You can always make changes, but this ensures you are both on the same page with expectations (and should the deal go bad, you may even have a tax write-off).

Mistake #3 – Not insisting on insurance of some kind and letting her keep the title (presumably for automobile registration). If the family member doesn’t have the money for the transaction, how do you think they’re going to be able to pay you back if something goes wrong?

Lesson: Keep collateral. I should have held onto the title of the vehicle until my family member paid me back, and I certainly should have obtained a copy of the insurance policy to make sure my collateral could be replaced if something bad happened.

Lending to “family” the second time: a success story

My good friend, David, had been a great employee of mine in corporate America, and I supported him with advice and motivation when he chose to leave and figure out his true career path in music. David was in his late 20’s. He was single, owned a nice little condo, a cool jeep, and an adorable cat.

The time came when he needed to buy a new vehicle and clear his debts in order to keep pursuing his career in music (which was actually going well). It made sense for him to sell his condo — he could rent for less than his mortgage and the debt was limiting his credit. In the meantime, he needed some cash to tide him over — $30k to be exact.

Putting the deal together

He came to me with a formal proposal (in writing), basically saying that if I could lend him the $30k he needed to buy a new vehicle and clear all his other debts right now, then when the condo sold he would reimburse me, with interest. It was big chunk of change, but it all went according to plan because we solved all of the mistakes and he and I became partners in his condo sale.

Assigning value — David and I worked together to sell his condo. We were realistic about the market value and I knew that if the sale didn’t happen and I didn’t get my $30k cash back, the value was still there.

Putting it in writing — We signed a Promissory Note and I recorded a lien on the property at the county in case anything went wrong.

Keeping collateral — What if the condo sale hadn’t gone according to plan? If I had been a banking institution I would have pursued David for the remainder, foreclosed on the property, taken him to collections or court, you know the drill.

Since he is a friend (and adopted family), I instead had to be prepared to walk away with my losses and the condo as collateral. Since I’ve been a landlord since I was 22, I knew I could use the condo either as a sale or a rental to offset the worst-case scenario; and David and I could still look each other in the eye and smile at family gatherings.

The result

I broke even on the deal, and David went on to become my business partner for 12 successful years, and remains my closest, surrogate brother. I’ve since been able to assist family with other needs, including helping my brother open and sell a successful restaurant in Madrid, an experience that we all profited from.

Thanks in part to the things I’ve done right in family and friends lending, I’ve been able to revel in their successes more, and even have a part of ownership in a number of businesses and properties that I never would have considered on my own. The successes are great stories at family gatherings, and with the right pieces in place, the failures are a laugh and a bonding moment.

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