What to know before lending money to family or friends

An older man embracing his young, smiling son and handing him a stack of cash

You may want to think twice before co-signing a loan

(Image credit: Nalinee Supapornpasupad / Getty Images)

Just as there are cautionary tales about mixing business and pleasure, so goes the story for getting financially entangled with family or friends. While lending money may seem like a nice gesture when someone you care about is in need and you have the means, there are a number of considerations worth weighing first to ensure your relationship — and your own financial situation — remains intact.

The key is "creating boundaries for loans to friends and family," which "can help preserve relationships and minimize the potential for problems," said Investopedia. Here is a rundown of some general guidelines to keep in mind.

Evaluate your own budget before agreeing

If someone asks you for a loan, remember that you are under no obligation to say 'yes.' "Ask yourself: Am I really in a position to be gifting money right now?," said Wendy De La Rosa, an assistant professor at the Wharton School at the University of Pennsylvania, to NPR.

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Maybe the answer is that you are comfortably able to. "But if you have to pull from the funds you've set aside for critical expenditures like your rent, your car payment or tax money," said NPR, "you are jeopardizing yourself," De La Rosa added.

Remember you can offer other forms of help

If you do not feel comfortable lending a loved one money — whether that is due to your own financial situation or hesitations about whether you will actually help solve their problem — remember there are other ways you can support them. For instance, instead of a loan, you might "offer to bring them dinner, or "help them with child care so they can pick up a few more shifts at work," said NPR.

One way of helping you may want to steer clear of, however, is co-signing a loan. This is because "co-signing a loan can affect your credit score, as the inquiry, payment history and loan balance will show up on your credit report," said Investopedia. If your friend or family member fails to stay on top of repayments, you will be on the hook.

Make a formal agreement before lending the funds

Ahead of handing over the funds, "you and your borrower need to decide on a plan for repayment — and it should be in writing," said U.S. News & World Report. Details to be sure to include are "the amount borrowed," "whether the lender is charging interest," the agreed upon "repayment schedule," specifics on "how the money will be used" and details on "what happens if you stop paying," said Experian. Even if this seems like overkill at the outset, it "keeps both parties honest and can prevent potential conflicts down the road."

Do not overlook potential tax consequences

A last thing to keep in mind when making a loan to a family member or friend is that you may face tax consequences. Specifically, "if the family loan is interest-free and over a certain amount," then "the lender may need to file a gift tax return," said NerdWallet. And "if the loan includes interest, the lender must follow IRS interest rate guidelines and potentially report it as income."

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Becca Stanek has worked as an editor and writer in the personal finance space since 2017. She previously served as a deputy editor and later a managing editor overseeing investing and savings content at LendingTree and as an editor at the financial startup SmartAsset, where she focused on retirement- and financial-adviser-related content. Before that, Becca was a staff writer at The Week, primarily contributing to Speed Reads.