December 10, 2015
One of the trickiest money issues you will ever have to navigate is when someone you love comes and asks you for a loan. Or if you see someone you love is having a tough time financially and you want to loan them money to help.
What I too often see is that incredibly caring and thoughtful people are blinded by their desire to help, and don’t carefully consider the ramifications of making a loan: for themselves and the recipient. That can just lead to heartache and bigger financial problems.
Before you offer a loan to anyone, make sure you can pass my 3-step Loan Test.
1.Will a loan really help this person? Do they need a loan because of some unforeseeable problem—a health issue, a layoff—or because they have made bad decisions with money and have a big hole to dig out of? If it’s the latter, I don’t think loaning that person money is necessarily going to help. Oh sure, your money might help them pay off some pressing bill, but if they don’t respect money, you and I both know they will likely just fall into more money trouble. Before you ever loan money to someone who has made bad decisions in the past, you need to be assured that they have begun to take the steps to becoming responsible with money.
2. Can you honestly afford to help? You are to never ever reduce your emergency savings to the point that it puts your own financial security at risk. You know that I think it is smart to always have eight months of living expenses set aside in an emergency fund. Any loan that reduces your emergency fund below the eight-month threshold is not respectful to yourself. Please don’t do it.
3. Are you comfortable thinking about the money as a gift, not a loan? I believe all loans should be repaid. That’s how the borrower shows their respect. But from a financial standpoint, if you honestly need the money to be repaid by a certain date, I would question whether you should make the loan.
When you give money to someone you love, I don’t have to tell you how high the emotional stakes are. Adding a layer of financial stress is dangerous. Think about the “what if” factor. What if the loan isn’t repaid? Not only is that a financial hit, but it likely will put a tremendous strain on a relationship with someone you love. You could be out the money, and on the outs with someone very important to you.
A good test for you is to ask yourself if you would be okay—emotionally and financially—if the loan was actually a gift that was never repaid. Be honest with yourself.
Answer Yes or No to the follow statements.
I pay all my credit card bills in full each month.
I have an eight-month emergency savings fund separate from my checking or other bank accounts.
The car I am driving was paid for with cash, or a loan that was no more than three years, and I sure didn’t lease!
I am contributing at least 10% of my gross salary to a retirement plan at work, or I am saving at least that much in an IRA and/or regular taxable account.
I have a long-term asset allocation plan for my retirement investments, and once a year I check to see if I need to do any rebalancing to stay on target with my allocation goals.
I have term life insurance to provide protection to those who are dependent on my income.
I have a will, a trust, an advance directive (living will), and have appointed someone to be my health care proxy.
So how did you do?
If you answered yes to every item, congratulations. If you are working on improving on a few items, I say congratulations as well.
As long as you are comitted to truly creating financial security, I applaud you. If that means you are paying down your credit card balances, or are building up your emergency fun with automated payments, that’s more than fine. You are on your way!
But if you found yourself saying No to any of those questions, and you’re not working on moving to Yes, then I want you to stand in your truth. No matter how good you feel, you have some work to do before you can honestly know what you are on solid financial ground.