With the unemployment rate hovering above 10%, people keep asking me…
“Should I loan money to my friend?”
First of all, if you're going to loan money to friends and family, you have to charge interest.
I’ve been asked for money dozens of times, but I’ve only granted two requests. One loan was only for a week, so it didn’t make much sense to charge interest there.
But the second one was a $2,500 loan for several months. I charged my friend 8% interest, compounded continuously. He paid me back, and I made about $74, but that wasn’t the point.
Now, you can laugh and think, “What a jerk!” But there are good reasons to charge friends and family interest on a loan.
For one thing, if they’re coming to you, it’s because they’ve exhausted all other possibilities. They can’t get the money anywhere else, so they probably pose a high credit risk. Charging interest is one way to recognize that.
Two, if it really is a loan, then you want to treat it like one. The bank wouldn’t loan someone money without charging interest. So why would you?
Say it's your brother, and he asks to borrow $50,000 to start a business. You want to draw up a contract, charge a reasonable interest rate, and treat it like a real business arrangement.
A lot of people are morally opposed to this. It’s sounds too much like Gordon Gekko. But again, it’s not about sucking $74 out of a friend. It’s about setting up the loan in a way that preserves your relationship.
In the back of your mind, though, you need to assume that any loan to a friend or family member is really a gift. Assume that you’re never getting the money back.
You have to be okay with that idea—really okay with it. If you’re not, then don’t lend him the money.
It might tick him off if you say no, but that’s much better than the alternative, where you spend years angry and annoyed because he never paid you back.
Plus, what are you going to do if he stiffs you? Blow up his phone on a daily basis? Hire a private investigator to comb through his financial records? Take him to small claims court?
That’s Jerry Springer stuff—you don’t want it anywhere near your life.
So again, if it’s going to bother you if you don’t get the money back, even a little bit, just say no.
I don’t really believe in charity—I believe in investment.
Longtime readers know that I love cats, and I donate money to animal shelters sometimes. But I don’t think of it as charity. There’s a return on my investment: I’m helping animals, plus I get a little feel-good psychic reward.
The same line of thinking applies to family and friends…
That $2,500 loan I made to a friend—he was a really good friend from my college days. I’d known this guy for years. But he was in the middle of bad divorce, struggling with substance abuse issues, and needed $2,500 to pay for a lawyer.
Anyone would have considered this guy a terrible investment. I talked to my wife about it, and she said the same thing—you have to assume he’s not going to pay you back.
I knew his character, though. And I considered it a good investment.
It was a one-in-a-million shot, but I was right. My friend quit drinking, got back to work, and paid me back… plus the $74 in interest. Today, he’s remarried with kids, a big house, and tons of money.
So really, it turned out to be the greatest investment of all time.
P.S. If you’ve got a repeat offender in your life, someone who’s always asking to “borrow” $50, chances are he’s got a big debt problem, too. Instead of loaning him money, you could pass along a copy of Mastering Your Debt, my no-holds-barred guide to eliminating debt and reclaiming your life. You can grab a copy here.