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Lending money to a family member

Shakespeare wrote that loaning money to a friend is a good way to lose both friend and money. So what do you do when a relative hits you up for a quick cash infusion? Tread carefully.

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Often, the First Bank of Dad (or Mom) is the first place people turn when they have financial trouble, and many do have a need. A recent survey by Fidelity Investments found that 41 percent of U.S. households did not have emergency funds sufficient to cover three to six months of living expenses.

The first choice for cash during an economic catastrophe? Family and friends.

So if Uncle Bob puts the bite on you at the next family barbecue, here are some things to consider:

  • Do you really have the money? "It's the same rule as gambling: Don't loan what you can't afford to lose," says Ira Bryck, director of the University of Massachusetts Family Business Center in Amherst. Even if you're driving a Mercedes and living in a good neighborhood, if you haven't got ready cash lying around, a loan might not be feasible.

  • What's the money for? Are you loaning your daughter $500 to put groceries on the table while your son-in-law is out of a job? Or does Cousin Ed want $15,000 to start a mink farm? And if you're loaning money for a small business, is the venture stable enough that you're comfortable with the risk?

  • Is the borrower likely to repay you? Look at the person's past behavior. If someone consistently borrows money and never pays it back, chances are he has no intention of repaying you.

  • Could the loan cause a rift in the family? This comes up a lot with siblings who borrow from parents, says Bryck. The one who doesn't get the loan thinks the parents are playing favorites. Or the siblings accuse the borrower of draining the inheritance. Bottom line: If you're the lender, it's your money to spend. But be discreet if you want peace in the family.

  • How much will the loan cost you, and is it going toward something that you value? If your nest egg earns 7 percent annually, and a family member wants to sideline $20,000 for five years, the real cost is $28,052. But you might feel it's a smart move if the cash helps Dad hang on to the house or enables your nephew to finish medical school.

  • Does the relative have other options? If the kids are in the habit of going to the Bank of Dad because the rates are so good, it might be time to introduce them to your local loan officer or credit union. Conversely, if their credit is so poor that they can't qualify, you need to know why.

  • Can you easily live without the money for the term of the loan? What will you have to do without if you give up the money? Even if you're "only" taking it from savings, will the loan rob you of a much-needed cushion if you're the next one in the unemployment line?
    Next: "Make sure the terms include a fair interest rate. ..."
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