Why We Ignored The Experts and Loaned Money to Family

we’re here today with a post we’ve been hinting at for a while: the full rundown on why we decided to go against conventional wisdom (and the well-grounded advice of many of you!) to make a personal loan to a family member. we wanted to make sure we had everything squared away before sharing the details, but now that time has come. it was definitely not an easy decision, but we took our time making the decision, and now feel good about it. here’s how we decided to make the loan, and the factors that swayed us.

starting from a place of “no”

if you had asked us six months ago if we would ever consider a loan to a family member, we would have responded with a knee-jerk “no.” there are a lot of good reasons not to lend money to someone you have a personal relationship with, but for us, the two biggies are:

  1. bringing finances into a personal relationship could change the dynamics, obviously for the worse, and could even affect dynamics beyond the immediate parties involved. that’s never something we would want.
  2. you’re unlikely to exercise any real legal recourse if something goes bad with loan repayment (meaning: you aren’t going to sue your relative or friend), which is why most experts say you should consider money loaned out to someone you know to be money you may never get back. we are mostly fans of good investments, not bad investments, especially bad investments that come with hard feelings.

those are hugely important reasons, so to us, there had to be several super compelling reasons why we should make the loan in spite of those risks. and yes, we’ve heard the horror stories, including the ones some of you shared in comments when we mentioned the possibility of this loan. we’ve seen some bad things happen in our own families from financial arrangements that didn’t go as planned, and we’ve never had an urge to repeat those mistakes.

the request

the request for the loan came from a first-degree relative who has accrued some pretty significant credit card debt, and wants to use the loan to pay it off. this credit card debt came not from shopping or from extravagant purchases, but from health care expenses. this person has also shown a real willingness to wise up financially and a sincere eagerness to get out of debt, and is having some legit success with a small business they started. (as a grammarian, using the plural “they” to talk about a singular individual pains me, but we want to protect this person’s privacy, so we don’t want to say “he” or “she.”) but like with most new small businesses, the income stream is not even and predictable, so we’re not positive how a traditional lender would view that.

the philosophical reason to get to “yes”

though our logical sides initially said “no,” there was admittedly a part of me especially that wanted to be able to say “yes,” for one big reason: i benefited from a loan very much like this one about a decade ago. i had some significant credit card debt, and was struggling to make a dent in it, even paying more than the minimum, because of the high interest rates. and, i’ll add, i did not run up that debt paying for legitimate needs like health care and groceries. i ran up that debt buying cocktails and shoes, a new couch i didn’t need, and traveling to date mr. onl during our long-distance year. to this day, i’m thankful that a relative stepped in to bail me out with a loan that let me get out of debt in under three years, something that would not have been possible if i’d been paying the banks directly at 18 or 24 percent interest. so a desire to pay it forward was present in our decision-making, but that wasn’t the only factor that swayed us, not by a long shot.

the deciding factor: security

as it turns out, we were not the first choice to make this loan. the borrower asked some other relatives, who wanted to help and have the assets to do so, but aren’t in a position to free up all the cash needed right this moment for tax reasons. but, they are enthusiastic and trustworthy supporters, and offered up what eventually became the deciding factor for us: security. most personal loans are known as unsecured loans, because there’s no collateral like a house or car to repossess if the borrower defaults. that type of loan is deeply unappealing to us. i’m sure it goes without saying, but we aren’t working our butts off to save for early retirement just to carelessly lend out a somewhat princely sum without any sort of guarantees. but we are actually getting two back-ups as our security on the loan, the combination of which makes us feel good about the loan: those enthusiastic supporters have agreed to be co-signers on the loan, stepping in if the borrower misses a payment or defaults, and we have an extra backup of a guarantee against an estate inheritance. obviously, we never want it to come to that, but it will help us sleep at night knowing that we will ultimately be made whole, even if this whole thing goes down badly.

how we structured the loan

interest rate and term: many of the terms of the loan were proposed by the borrower when they first came to us, including the interest rate. for something like this, it makes sense to have an interest rate that is substantially lower than the credit card lenders charge, but substantially more than a savings account would net, so that it’s mutually beneficial to both the lender and borrower. for this loan, we agreed at an interest rate of 6 percent. six percent is low enough that our borrower will be able to pay us back in five years, but high enough that it will grow our retirement nest egg even if inflation goes up during the repayment years. (and, heck, it’s way more than we’d get from any sort of banking instrument or account right now!) it’s a lower rate than we’d get on a platform like lending club, but those sites don’t often have a lot of loan inventory, and this loan is long enough that we trade a higher interest rate for a more predictable degree of certainty over a longer term.

amortization: when the borrower approached us about making the loan, they proposed a standard, front-loaded amortization schedule, which we appreciate. however, since we’re currently in a high tax bracket, but will be in a much lower bracket after we retire, we didn’t want the biggest chunks of interest taxed highly while we’d be getting much less interest in the years when it would barely be taxed. so we, maybe uniquely among lenders, proposed a schedule in which the interest is evenly distributed over the life of the loan. it’s still the same total amount of interest that the borrower would pay back in a traditional amortization schedule, so if the loan goes until the end, we still end up with the same amount. if the borrower pays us back early, then, sure, we’ve missed out on a little interest, but we can also reinvest that money sooner. so this is another term we’re comfortable with.

proper legal documentation: this one was important to us. we drew up a promissory note using a credible online legal site, and we verified the language with a few other sources to make sure we had a complete contract. the form we used was for a secured loan with guaranty (co-signers), and all parties signed before any money changed hands. in the unlikely event of a default by both our borrower and the co-signers, we want this legally valid contract to demonstrate our claim against the estate which serves as our security. of course, we never plan for it to come to that, but we want to be covered, just in case. and, we included the full amortization table in the promissory note text, should we ever get audited and need to demonstrate that amount of interest payment we’re receiving. (we plan to declare all of the interest on our income tax returns. high income = high audit risk, so this isn’t even a question.)

automatic, scheduled transfers: we don’t want to deal with paper checks, or with somewhat unpredictable payment timing. so just as we insist for the rent we receive from our rental property, we made it a term of the loan that we’ll receive our monthly payments via scheduled, automatic transfers directly into our checking account. and there’s a late fee if it doesn’t happen as scheduled, not that we expect any problems on that front.

the benefits to us of making the loan

though a personal loan was never a part of our financial strategy, and it’s not something we would have chosen to do if we didn’t care a lot about the person we’re lending to, this loan does come with some pretty solid benefits to us:

cash flow in retirement: assuming we work two more years (we’d love for it to be one more, but the markets gave us a good and proper smack down last week, making us less optimistic!), we’ll have three more years of loan repayment after we’re in retirement. our plan while we’re still working is to reinvest the principle and interest payments we receive each month into our vanguard or cash accounts, but after we stop working, the monthly payments can serve as part of our cashflow. this will reduce the amount we have to withdraw from our investment accounts for each of the first three years of our retirement.

guaranteed gains when the market is flat or down: mr. onl tells me that a “poo poo face market” is not a thing, even though i want to call it that. with the markets completely flat in 2015 and in essentially a nosedive so far in 2016, a 6 percent return on a secured loan feels like a pretty sweet deal for us. if you can think of another way to get 6 percent guaranteed right now, please raise your hand, because we sure can’t.

diversification: most of our portfolio is currently invested in the markets one way or another, with a smaller chunk invested in our rental property. this loan gives us some extra diversification for the loan period, and given the current market volatility (or “poo poo faceness”), we’re happy about that.

the hard realities we’ve had to confront

we said it earlier, but we’ll say it again: this has not been an easy decision. we took nearly two months to mull it over after we got the request. we consulted expert opinions on the topic. we had some major heart-to-hearts. we had some tough conversations with our borrower and co-signers. and we’ve accepted some tough realities:

despite our best intentions, it could still hurt relationships. we’ve had multiple long conversations with every combination of people involved, and we’ve tried to head off potential problems. but this could still end up harming a relationship or two. we for sure don’t want that, but we also see a loved one who’s in a tough financial spot, and without help from us or someone like us, they will have a hard time being able to build a positive financial net worth. we want to be part of the solution, and are accepting the risk that comes with that.

we could lose the money. despite vetting the borrower’s income and assets, despite securing trustworthy co-signers and despite having the final backstop guarantee of a share of an inheritance, we could still lose all or part of the amount we’ve loaned out. that’s not the outcome we want, and it’s not an outcome we would accept without trying to work something out, but we’re going into this knowing that it’s a possibility. timing is everything here: knowing we’re ahead of schedule on our early retirement plan, and that we’re likely to go into our retirement with a bigger cushion than we need, gives us the confidence to proceed with the loan. if, in the next two years, we get signals that the loan is shaky, we can keep working a little longer to make up the difference, but it would be quite different if we were being asked to make this loan after we had already quit. in that case, it would be awfully hard to say yes.

so there you have it, friends. 2100 words on our decision to make this loan. now it’s your turn: tell us what you think of our choice. would you make the same decision under the circumstances? think we’re being optimistic idiots? ;-) we’ve heard some stories of negative experiences lending money to family, but anyone have any positive stories to share? anyone else like me in benefiting from a family loan? please share!

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63 thoughts on “Why We Ignored The Experts and Loaned Money to Family

  1. I agree that loaning money to family can be a dicey situation, but it definitely looks like you guys are doing it the right way by making it legal and documented. And I’d put another positive into your list that you’ve already come up with: karma within the family. I bet if something does go catastrophically wrong financially, not only would your borrower assist in any way that they could, but the rest of your family would as well knowing that you helped this person get themselves out of debt.

    For us, being only a year out (hopefully), I can’t see engaging in this type of thing at the current point in time. It would probably lengthen our working years at this point and that is definitely not something that I would entertain unless we’re talking about a life-and-death kind of situation. Knock on wood.

    Good on you guys for being so willing to help a family member in need. :)

    1. Fortunately we are part of families that would help us no matter what, no extra karma needed, but I’m sure that’s part of what motivated us to want to help since we could! :-) I agree with you on timing — if we really were just a year out (less likely, but still possible), we’d be less stoked to make this arrangement because we wouldn’t have time to make up the difference. But since we think we’re most likely still working two more years, we knew we could do it. But yeah — we definitely wouldn’t want to have to work longer to do it! Can’t blame you for taking that point of view! :-)

    1. Agree with you, Jim! There’s a huge dose of optimism and hope and maybe even fingers crossed going into all of this. We’ve tried to think and talk about everything, but we still know it’s a sticky situation. Here’s hoping it all goes smoothly!

  2. I hope it works. Your situation is unique in that you received a loan yourself AND you put in the additional stop gap provisions. That will help you get paid, but it may not prevent any hard feelings.

    I’m not a fan of personal loans. Though I do appreciate that they helped me learn early (and with smaller sums of money) that being a lender and especially a collector is not a good role for me.

    1. Trust me — we have thought about this side of it the most. I also don’t want to be a collector, and think there’s lots of room for hurt feelings in this. But we also felt like we wanted to help, and ultimately decided to suck it up and be grown-ups and work through the feelings in order to help out a beloved relative. We’ll see if that was the right decision or not!

  3. Sounds like you have done your homework. Having collateral is very important, especially if the collateral is longer-term in nature. Once we were asked for a loan from a family member and they wanted to use their car as collateral. That doesn’t practically work, because if they ran into hardship they could lose their vehicle as well. Congratulations on really thinking this through – I hope it works out well for you.

    1. Your comments a few weeks ago were helpful in thinking this through, so thank you! Yeah, the collateral was necessary, especially “real” collateral. I assume you didn’t make the loan with the car as security? Definitely agree that would be problematic! Thanks for the well wishes!

      1. We have two loans out on real estate that are secured & registered as mortgages. I have a small personal loan out without security (he offered his vehicle) – I probably won’t see that again and it has become relationship friction.

        1. Wow, so with the two real estate loans, you actually registered them as mortgages! That’s above my knowledge level, but makes total sense to me. And yeah, the other loan sounds a lot like the few that I witnessed earlier in life between other family members that made me say I’d never want to get into this kind of thing. I hope you get some resolution on that at some point, for the sake of the relationship if nothing else!

  4. It sounds like you’ve done this as wisely and carefully as possible, and are also in touch with the worse possible outcome, and willing to accept it. Not that it sounds likely. I think the fact that you are doing this from a place of grace and compassion, having been in a similar position yourselves, is very powerful and beautiful. Best wishes for the outcome for both you and your relative.

  5. One of the great privileges of having a high savings rate is the ability to help others when they need it, so I respect your efforts. You’re obviously doing this because you care rather than to earn a nice return. Sounds like you’ve done everything you can to make it a success.

    I made a personal loan like this just once, and my biggest mistake was not getting commitment on a firm repayment schedule. I got my money back, eventually, but it got awkward before the money was returned.

    1. So true — we are in a position of mega privilege, and we believe in the responsibility that goes with it. (But we also don’t want to make dumb choices and put ourselves into a position of hardship!) Sorry you had a bad experience — we put the actual payback schedule, with amounts and dates, in the legal doc, so hope to avoid any misunderstandings there!

  6. First of all: https://www.washingtonpost.com/news/wonk/wp/2016/01/08/donald-trump-may-win-this-years-word-of-the-year/
    I’m with you on “they”, but we really do need a gender neutral word for the third person singular in English!

    Props to you guys on how much you fleshed this out. I hope it works out! My sibling wanted to take a course in the last few years that they didn’t have the savings to take (it cost under $5,000 IIRC), but would jumpstart hir earnings. My parents are super controlling with money which they hate, so I gave some money to my sibling for a portion of it. They wanted it to be a loan but I didn’t want to be like my parents (which I definitely can be!) so I just transferred the money to my sibling directly and said I didn’t expect anything back, but please enjoy the course! It really did kickstart their earnings and it’s been great to watch them flourish in their career!

    1. OMG — thanks for that link! I still object to the singular “they.” :-) And we DO need a gender-neutral option!

      How awesome that you just paid for your sib’s course! That’s so wonderful and generous. I *wish* we could just gift this money, but it’s too much for that to be a possibility. We do need it back!

      1. I only paid for part of it – my parents paid for the rest and then got mad at me for giving my sibling money and said I should ask for it back so my parents could give us both the same amount! My parents have an interesting perspective on money ;)

  7. I think you made the right choice… but I’m a sucker for things like this. Of course it would depend on who it was in my family. I certainly trust some more than others, but you’ve thought it out and covered your tracks. My guess is that it will go as smoothly as hoped. But you’ve planned for the worst, so it shouldn’t be a complete loss.

  8. Well done! This is a beautifull story on how emotions and rationale can be mixed in a good result. I hope you never need to draw on the guarantees.
    To me it proves that you as a couple have the right priorities and a broader look on happiness.

  9. We were the fortunate recipients of a loan from a family member. There was one significant argument concerning a large expenditure that we made, which came with some accusations and hurt feelings. But everyone got over it. The loan was paid off in full and now we all get along just fine. We do rent our first house to a friend right now, which could cause similar issues. However, two of the reasons that we chose to rent to him is because of his dependability and responsibility. There have been a couple of late payments over the past few years, but no other issues. You should be fine with all of the terms and guarantees in writing, so there won’t be any misunderstandings.

    1. Thanks for sharing your experience! Glad I’m not the only one who has benefited from a family loan. :-) Like you said, we tried to cover just about everything, so that there’s no room for misunderstandings, and everything should be automated so that late payments aren’t an issue. Fingers crossed!

  10. I’ve lent money to my siblings, but only because their college funds took a nosedive moments before they started school, and my parents used up all their money to re-invest their business, so they were cash poor too. In this case, my parents were co-signers, and they ultimately paid the interest on the loan too. I think we had it set for 5%, and the total length of the loan only ended up being a year because the markets recovered enough to cash out and pay for school.

  11. That’s some pretty thorough planning on how to set this loan up so it goes down the best way possible. If I was in that same situation, and could have all the arrangements set in place with guarantors, and estate inheritance, then I’d probably go along with it too.

    I don’t have any positive loan stories, but after I got my job out of grad school, my sister hit me up for a $2k “loan”. I wasn’t going to have any part of it, since the money would most likely not go toward any debt, but rather funding her poor lifestyle choices which led her to needing to ask for money to begin with… Also, I felt I’d never see that money again. Maybe some of it, but not all of it and I didn’t want to start a perpetual cycle of borrowing.
    After discussing it with Mrs. SSC, we decided we’d shut it down by getting her to sign a promissory note, and add some interest on there as well. Similar rational as you used, not a lot but more than a savings account. Needless to say, I haven’t been asked for any money since, lol.

    I don’t mind helping out, but I don’t want to enable bad behaviors either.

    1. The enabling thing was something we thought long and hard about! We don’t want this to become a thing, that people come to us for everything (after all, we had previously bought a rental property for a relative on the other side of the family to rent from us, which was a different kind of help, albeit a good investment for us under any circumstances). So we’ve made as clear as we can to everyone who knows about this loan that this is a one-time deal, and we can’t do any additional help after this to anyone without jeopardizing our own well-being. Fortunately, we have pretty financially responsible people on both sides, and this one case is a fluke from health care expenses. So we hope this one goes smoothly and then we’ll be out of the personal loan business! :-)

  12. Glad it all worked out and good job doing your diligence. One question – I don’t understand your amortization. Are you just letting the interest build and applying the payments to “principle” so that you then can switch over to interest payments in low income years? Didn’t know that was a thing. But interesting, was there IRS precedence that you found? Thanks.

    1. Short answer is yes, letting interest build. We calculated the total interest over the life of the loan, and are just splitting the principle and interest equally across each payment for simpler accounting. We are not tax experts, but based on what we’ve seen, it should still avoid the IRS imputed interest problem because each year still has a reasonable interest rate when taken as an individual year.

  13. Loaning money to a family member is always a tough decision but I think you guys did the right thing. Your evaluated the situation and made a decision to help instead of feeling pressured to either to say yes or no right away.

  14. I think the pay it forward aspect is what’s one of the most important things for this personal loan! As you said, it isn’t consumer debt – but medical debt that put this family member in this setback, and I think you may find that helping someone you care & love will pay dividends in other ways (not just the 6% interest). It is a tough situation, but money always has emotional components whether it’s personal loans, investing, donating, etc. Since you spent 2 months to determine a final answer and put back-up precautions (even legality wise) into place – I think this was a sound decision!

    1. Thanks, Alyssa! We never want to be those people who have lots of money but no friends, and we actually think that spending to support relationships makes total sense with our financial philosophy. And this was one of those moments when we could choose to help or choose to close the door. We’re feeling good that we chose to help. :-)

  15. Wow, this is SO interesting. I admit that I would be unlikely to loan money to anyone, but that’s partly because I basically don’t have any, haha.

    But in all seriousness, I really admire your willingness to help a family member out, despite the risks, and to think through it so logically and thoroughly. I really hope it turns out well. I bet it will.

    1. Thanks, Sarah! Ever since we first mentioned this possibility, we’ve heard nothing but cautions against making the loan (that’s in addition to all the conventional wisdom against it), so the whole thing has made me a little queasy. (That whole “trust your gut” thing definitely applies to me — my stomach always lets me know when something isn’t a good idea.) But now I feel at peace with it all and not the least bit unsettled, which I think means something important. So fingers crossed it all goes smoothly!

  16. I’ve wanted to chime in on your blog for a few weeks now–I’ve become a regular reader and love your perspectives. This is a situation I’m pretty familiar with. My parents gave me a loan for graduate school, instead of me taking a private loan. The interest rate was FAR cheaper than what was available on the market. I paid it back as fast as I could, because it was to my parents. And they knew I was good for it, of course.

    I’ve also made a very small loan to a friend and co-investor in a small business that turned out less well, but we are still friends. The loan amount was small and there were many extenuating factors–they worked full time on the business while I was long distance, so they bore most of the risk.

    Thanks for sharing and thanks for your consistent blog postings! I look forward to know that there will always be at least two postings per week–helps to get through long January weeks with no daylight!

    1. Hi Lucky Girl — thanks for commenting! So happy that you’re enjoying the blog. :-) Your comment totally made my day! How great to know that you have benefited from a loan yourself and managed to stay friends despite a less-than-perfect outcome for a loan/investment you made. Hope your week is off to a great start!

  17. I think everyone has already covered everything I was going to say, but I think it sounds like a good decision, if only that you considered it so thoroughly – and it was a very kind move (I think, anyways!)

    Also, in terms of using “they” as a singular pronoun, I know all too well how weird it can feel! I have a close family member whose significant other goes by the singular pronoun “they”, and adapting to it in speech has been tricky, and I’m always highly aware of my language when I’m speaking with or about them, especially to their partner.

    1. Thanks for adding to the support — it helps us feel good about the choice! :-) And glad you can relate on “they”! We actually have another relative who is a young trans person, so can relate on the pronoun front, and how easy it is to slip into old ones, not out of lack of consideration, just out of habit. No amount of love and affection can make me always use the right pronoun — this is something I have learned. :-) But I’m getting better! Thank goodness for understanding relatives!

  18. I love the idea of paying it forward. It sounds like you know exactly what you are getting into and trust in this individual (and “their” backers :) enough to make the “yes” decision. The fact that you are treating it as a true loan with the legal paperwork is a good idea. It makes everyone involved feel like this is the real deal. It must feel really good to be in a position in which you can help a family member in this manner. THIS is what financial independence is all about! Congratulations!

    Mrs. Mad Money Monster

    1. I love your point — that this IS what building up a strong foundation is all about: being able to help those we care about. And bonus that it helps us too if it all goes to plan. So true — we never want to be misers who refuse to share in our good fortune! :-) Thanks!

  19. Your description of this still makes it sound like an unsecured loan, albeit with several co-signors. Is the collateral the right to an inheritance itself? I’ve never seen someone perfect a security interest in a right to an inheritance. How do you do that? What do you do if the person leaving the inheritance changes their mind about leaving it?

    1. I can’t share too much without giving away the identities of those involved, but bottom line is we’re not concerned about minds changing. AND, we’re truly not concerned about the actual security since we know our borrower is trustworthy and our co-signers are especially trustworthy, so the chances that it ever comes down to the inheritance are close to zero. But, we’re not legal experts, so if you were considering something like this, it would be up to you to get advice you trust!

  20. I think this a really important post for us in this community to think about. The vast majority of people don’t understand the math of early retirement and so just will assume that we can afford to give/loan money out and so I’m sure we’ll all have some version of this request at some point.

    I have very mixed thoughts reading this post. You guys obviously did your homework on this and tried to cover all your bases in communication with all parties, covering yourselves legally, etc. At the end of the day, it seems that your hearts were telling you to do it and your guts were telling you not to and you ended up following your hearts.

    I think if it was an amount of money that I had to do all of the things that you did such as drawing up legal documents and getting collateral and involving other family members, I would have not done it. However, no one knows the ins and outs of the situation better than you, and we all need to learn to trust ourselves and make tough decisions.

    Hope it works out for you!

    1. I think, in all honesty, our hearts and heads both wanted to do it to be helpful, but what held us back was how clear and unified the conventional wisdom is around this stuff. Our relative is trustworthy, and our co-signers are ultra-trustworthy, and I think the experts who weigh in on this stuff assume a certain level of flakiness that just isn’t there in our case. And we did the legal docs as much at the insistence of our borrower as anything. But, you’re right that this is never an easy choice, and if asked, there’s no perfect answer. Saying no would have felt bad, saying yes made us feel like we needed to have a lot of talks. We feel good about our decision, but it’s SO specific to the circumstances, and we would never tell anyone else that they should make the same choice.

  21. Having read your blog for a long time now you seem like really nice people, but I still think that loans like this are a bad idea and that you are leaving yourself exposed. I had written a post on this before you published this post which covers some similar and some different issues, but overall I think it’s bad news. I hope it works out for you!

    1. The truth, of course, is that any investment with the potential for a gain beyond the microscopic interest rate of a savings account leaves the investor exposed. We did our due diligence and are comfortable with the level of risk on this one. Besides, we believe strongly there’s more to life than math. If you can’t once in a while help out those you love, what’s the point of it all?

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