Think before lending money to family members

YAKIMA, Wash. -- Personal finance consultant Suzi Williams keeps her advice simple when it comes to loaning money to relatives.

Don't do it.

"It's a great way to have a family member not speak to you again," she said.

With that warning, Williams joins a chorus of experts who say loaning money to someone close can ruin a relationship.

Not that he was a financial adviser, but even William Shakespeare chimed in on this one: "Neither a borrower nor a lender be; for loan oft loses both itself and friend."

Dave Ramsey, a popular author who runs a syndicated radio advice program, has penned similar, if less poetic, sentiment.

Granted, Ramsey opposes all forms of debt, but his advice is extra clear about interfamily loans. In his book, "The Total Money Makeover," he writes, "Don't put that burden on any relationship you care about."

Williams, a Yakima adviser for the Credit Union National Association, has learned the hard way, she said.

Nearly 20 years ago, her younger brother, a lumber worker fallen on tough times, borrowed $300 for his kids' school clothes. Or so he said.

Two weeks later, she spotted him wearing a new pair of $200 cowboy boots. He flat out told her, "You can afford it; you make more money than I do," she said.

It was true. She could have simply given him that money, but she still resents the assumption to this day. Since then, she has given -- not loaned -- money to her children, all adults now, and to his kids, also adults, but never again to him.

Williams tells that story to her clients over and over.

"I too have been emotional and loaned a family member money and got burned on it," she said.

Common reasons for interfamily loans include helping someone start a business, making a mortgage down payment and getting back on their feet after losing a job. Williams usually encounters interfamily loans when parents withdraw some of their retirement savings to help a child catch up on bills or pay down credit card debt.

It all seems nice, but too often those kids regard mom and dad as more forgiving than a bank when times get tight, she warned. She usually advises her clients to simply give their children an amount they can afford to live without.

The same lessons go for co-signing loans, said Dave Gilbreath of Consumer Credit Counseling Service of Yakima Valley.

Nationwide, 70 percent of those who co-sign on a loan end up paying at least some of that debt, Gilbreath said. He imagines the informal "handshake" loans between family members have even worse statistics.

Chances are, the reason the family member is asking for a loan is because they couldn't qualify for one at a bank, he said.

And legal documents outlining plans for a loan will do little; they only work if the lender sues.

"How many fathers or mothers are actually going to take their kids to court?" Gilbreath said.

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It's not all bad, however.

Tom Lathen of Sunnyside loaned his son, Mitch, about $3,000 last year to help him keep up with rent payments.

Mitch, a Western Washington University graduate, was living in Portland and having trouble finding work. Lathen considered giving his son the money but decided to loan it to make Mitch more comfortable.

"He didn't want to take any more money from his dad," Lathen said.

Lathen, a spokesman and physician recruiter for Sunnyside Community Hospital, already had paid for most of his son's college education.

Mitch has since moved back to Bellingham and found a retail job. Last month, he sent his first payment -- a double payment of $500.

Experts give practical advice for people like Lathen who loan to family members.

They suggest checking your own credit score first, because loaning money can affect it. They also advise you to write out agreements ahead of time and set reasonable interest rates because even informal loans have tax implications.

"Handle these wrong, and you could find yourself paying income taxes on money you never received and gift taxes on money you never gave away," according to Small Money's smallbiz.com Web site.

Virgin Money, a subsidiary of the music recording giant, has turned these so-called "social loans" into an industry.

The company helps draft legally binding documents to "help protect your relationship," according to its Web site. Using the online service costs $99. Since it started in 2002, Virgin Money had steered more than $450 million in social lending.

Nolo.com, a Web site with a variety of legal tips, books and forms, includes products about social loans. Some of them are free.

The authors see no problem with borrowing money from family and friends. Here's the opening salvo of "Business Loans from Family & Friends: How to Ask, Make It Legal & Make It Work," a $20 book written from the borrower's perspective: "One of the biggest myths about private lending is that entrepreneurs like yourself are essentially preying on the charitable instincts of your friends and family. ... The truth is much different."

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One Yakima father did not follow that advice.

He loaned nearly $60,000 in a combination of informal loans and co-signing for student loans, car loans and credit card debt to his three sons. The father, a Yakima executive, asked to remain anonymous to avoid embarrassing his boys.

About $3,000 made it back to him.

He turned those loans into gifts, but not before some tense family moments. Even romantic dinners with his wife were soured by the debit.

The tension is gone now, said the father. Two of his boys are married and own their own homes, and the other is engaged. All have favorable credit scores today.

"It did strain relationships ... but it's just something you have to get over," he said.

The gifts have paid off in frequent family visits, the father said, and perhaps in other ways still to come.

"Maybe they'll put me in the best nursing home they can afford," he quipped.

* Ross Courtney can be reached at 509-930-8798 or rcourtney@yakimaherald.com.

If you're loaning money

If you decide to loan money to family members or friends, heed these warnings from the experts:

* Check your own credit score. It could be lowered, even if the borrower pays you back on time.

* Set up a reasonable interest rate and document payment terms and collateral on paper. Perhaps set up an automatic monthly bank transfer.

-- Source: www.credit.com

Tax implications

* Even informal loans have tax implications. The Internal Revenue Service may consider a loan with no interest a gift, and you are allowed only a certain amount of tax-free gifting on your tax return.

* If you do charge interest, you could end up paying tax on it even if the borrower is a deadbeat. It's called imputed interest. Check the IRS's applicable federal rate, which is set monthly.

-- Source: www.smsmallbiz.com

Web resources

* nolo.com

* www.virginmoneyus.com

* www.credit.com/credit_information/loans/The-Best-Ways-to-Loan-Money-to-Friends-and-Family.jsp

* www.smsmallbiz.com/taxes/Seven_Safe_Ways_to_Loan_Money_to_Your_Family.html

* www.bankrate.com/brm/news/pf/20020724a.asp

* articles.moneycentral.msn.com/CollegeAndFamily/RaiseKids/TheRightWayToLoanMoneyToFamilyMembers.aspx