When a friend asks for money . . .

Hope you enjoyed a peaceful holiday season and welcomed the new year with joy. Our holidays revolved around my son’s basketball commitments, but we managed a brief escape to Vegas during his days off. As a vegan/vegetarian family, Vegas had an abundance of dining options open during the holidays and a host of family-friendly activities. It was our first family trip to Vegas, and it was definitely a hit. The highlight was Matt Franco, truly a must see. Let me know if you want to see the rest of our itinerary.

As promised, this issue delves into the sensitive subject of providing financial assistance to friends or family. I’m of course aware that most people do not have the luxury of having a willing or financially able friend or family member to turn to in times of need. Having had the privilege of providing assistance on multiple occasions, I have become intimately familiar with this topic. Given my experience, I decided to dedicate an entire issue to it instead of briefly touching on it in the last newsletter.

Explore credit counseling
If your friend is burdened with credit card debt, start by exploring whether credit counseling is a viable option. The CFPB recommends working with one of two nonprofits: the Financial Counseling Association of America (FCC) or the National Foundation for Credit Counseling (NFCC). Of the two, I found NFCC more helpful. 

Put on your oxygen mask first
If counseling is not viable, consider offering financial support. But don’t forget, just as airplane safety procedures advise securing your own oxygen mask before helping others, the same principle applies to financial assistance. Make sure to assess your financial stability:

• Job security: Is your employment situation stable?

• Savings: Do you have savings that equals at least six months of living expenses?

• Debt status: Do you have any high-interest loans?

• Monthly budget: Are you earning more than you spend each month?

If the answer to any of these questions is no, it’s best to get your own financial house in order. Offer guidance and emotional support instead. 

Is providing financial support justified?
Helping a friend financially is more than just a monetary decision; it's an emotional one, too. Before opening your wallet, evaluate the merit of the request:

• Merit: Is the request justified? Can you trust them to use the funds as intended? Do you agree with their intended use of funds? Do both you and your spouse support this decision?

• Relationship dynamics: How significant is this person in your life? Would their close family or friends be more appropriate for this kind of support?

• Mental health/substance abuse: Be aware of any underlying issues, such as mental health or substance abuse, that might be influencing their financial situation.

Gifts vs. loans
My preferred approach when supporting friends and family is in the form of loans instead of outright gifts. My belief is that empowering people to maintain their independence and self sufficiency is crucial for their self esteem and life satisfaction. However, we have made quite a few exceptions to this approach. 

In situations of death or disability, where an individual cannot provide for themselves or their family, offering a gift rather than a loan is more fitting. In many families, it’s common for some members to sacrifice their education or career for the benefit of others in the family. Providing assistance for those that paved your way is not a gift, it’s a moral obligation. My parents have supported many family members in India that helped them get to where they are today as well as in response to unforeseen tragedies.

If you choose to extend a loan, below is my playbook for personal loans (business loans/investments require a different approach). The aim is to provide a lasting hand up instead of a one-time hand out. 

Review finances
Start the process by meeting to review your friend’s finances. This exercise aims to educate your friend about their finances as well as give you an understanding of their ability to repay a loan. Make sure to document your conversations for future reference. 

Construct a detailed spreadsheet of their debts and assets. Have them run a free credit report online and review it with them. Understand the key details on each of their debts: loan balance, principal versus accrued interest, current interest rate, variable vs fixed rates, upcoming rate increases and balloon payments. Have them call each credit card company to inquire if they can offer any debt forgiveness, penalty waivers or reductions in interest rates. Proceed to reviewing their assets. If they have high-interest-rate debt, look into selling liquid assets to pay them off. If they have illiquid assets such as real estate, discuss the feasibility of selling them. 

After the balance sheet, the next step is reviewing their monthly budget. Tabulate their income and expenses in a separate section or tab of the spreadsheet they have been preparing. Review recent credit card statements to identify any spending categories that may have been missed. Brainstorm ideas to generate more income: asking for a raise, taking on a part-time job, tapping into the gig economy or starting a side hustle. Review each of their expenses and options to cut costs. This could include getting a roommate, finding more affordable housing or canceling subscriptions.

Recognize the sensitivity of the discussion. Discussing personal finances can be daunting and make one feel vulnerable. Approach the conversation with respect and an open mind. If tensions arise, don’t hesitate to pause and resume later. The ultimate goal is to prepare a revised budget that generates adequate savings each month. 

Providing a loan
Once you have a grasp on their personal finances, you can discuss the prospect of providing a loan. Discuss why they came to you for a loan instead of another financial institution, friend or family member. To avoid gift taxes, personal loans require a minimum interest rate known as an Applicable Federal Rates (AFR). I only consider offering personal loans if rates from other institutions are significantly higher than the AFR.  

If there is no other viable option, discuss the loan amount and repayment period. Once an agreement is reached, prepare a written loan agreement that is signed by the lender, the borrower, and their spouse if applicable. Depending on the loan's size and your relationship with the borrower, you can use an online loan agreement template or ask a lawyer to draft a more detailed contract. While the agreement can be simple, it’s critical that it’s in writing. From my experience, the most common mistake in loans between friends and family is a lack of documentation. Even with the best intentions, misunderstandings over terms can strain or even break relationships

After all parties have signed the loan agreement, prepare a loan repayment spreadsheet that includes interest and principal payback of every payment. You can find many free loan repayment templates online. Track payments as they are made until the loan is paid in full. 

Here is a summary of the entire process.

1. Credit counseling. Is credit counseling a viable option?

2. Financial resources. Can you afford to help financially without straining your own finances?

3. Merit of a loan. Should you extend financial assistance in this situation?

4. Nature of support. Is a gift or loan more appropriate?

5. Financial diligence. Have you conducted a thorough review of their finances?

6. Budget. Do you have a revised budget with enough savings to pay back a loan?

7. Documentation. Has a loan agreement been signed by the relevant parties.

8. Repayment spreadsheet. Have you created a spreadsheet to track loan payments?

Remember, the primary objective is to aid your loved one while preserving your relationship. If you have reviewed their finances and agreed to an appropriate repayment schedule, the likelihood of repayment is high.  

My friend is on a good path
Let's revisit my friend’s situation which we discussed in the last newsletter. The process began with an in-person meeting to understand my friend’s needs. He requested a $10,000 loan. My friend and his daughter prepared spreadsheets with their assets, debts, income and expenses. We reviewed their credit card statements and credit reports. Their credit card debt was $45,000, of which $15,000 was accumulated interest. Their monthly family income of $10,000 was consumed by $8,000 in living expenses and $2,000 in minimum credit card payments. 

After reviewing their finances, I concluded that loaning them $10,000 was not an effective solution. $10,000 would temporarily reduce their credit card balances to $35,000. However, with a 30% interest rate, their debts would quickly grow back to $45,000 and beyond. There were two viable paths. They could stop paying their bills and eventually declare bankruptcy or I could clear their entire credit card debt.

We opted for the latter with monthly payments of $2,000; the same amount as their minimum credit card payments. By paying off their balances within 24 hours, we were able to negotiate a $3,000 reduction in their debts. To provide some breathing room, we agreed to start payments after 30 days. At a 5% interest rate, they will be able to repay the loan in about 22 months. It’s now been three months and 20% of their original debt has been cleared.  

The experience was enlightening for me. We called multiple credit counseling organizations and none were able to offer a viable solution. Most of the credit card companies were not willing to reduce interest rates or waive any debt; even accrued interest. Not even Apple! 

I am optimistic about their financial recovery. In the coming months, they should be able to refinance their other debts at lower rates. My friend is negotiating a raise and his daughter is attending school on nights and weekends which should lead to a promotion or improved job offers. If we look forward two years, they will have repaid their loan, be saving more than $2,500 per month, and building up a down payment on a home.

A personal request
This experience has inspired me to research solutions to help others in similar predicaments. If you know individuals, non profits or businesses tackling this issue, please let me know. I recently watched the Bank of Dave. Great movie inspired by a true story on a similar topic. Really has me thinking.  

Sangeeth Peruri - Jack of Many Trades, Master of None
P.S. If you like this article, please share on social media or forward to a friend! Click here to see past issues. 

Additional tips
For those considering lending money to a friend, let me review a few odds and ends. First and foremost, be prepared to not getting paid back. It’s not practical to pursue legal action to force repayment from a friend. The process is costly and unlikely to result in significant recovery. Accordingly, it’s crucial to remember that it’s ok to say no when asked for help. This decision is deeply personal and you should do what’s best for you and your family. My mother often lamented that her father would lend money to anyone that asked to the point of their own family almost going broke multiple times. This is not a path I would advocate.   

Ensure that your loved one is receptive to your assistance. It’s appropriate to gently indicate your willingness to help, but avoid pressuring them. It's best to wait until they are ready and willing to accept your support.  

When paying off debts, I recommend paying them directly instead of writing your friend a check. It’s best to avoid the risk of your funds going towards an extravagant purchase or helping other family members instead of paying down debts. After paying off credit cards, cancel any unnecessary accounts and initiate a credit freeze. Doing so reduces the risk of identity theft, increases the likelihood of repayment and reduces the temptation for unnecessary spending. 

If flexibility is needed in repaying a loan, be forgiving. If extra time is needed to make payments, that’s ok. I recommend requiring a payment every month, even if it’s small, as it’s important to maintain the habit of monthly repayment. We adjusted a number of personal loans during COVID, for example, when a few borrowers’ earnings were impacted. 

If the individual borrowing money owns real estate, secure a 2nd trust deed. While this measure provides extra security, you are unlikely to evict someone you know out of their home. Additionally, if feasible, request to be named in the borrower’s life insurance policy until the loan has been repaid.

Lastly, make sure to consult with your accountant before making a gift or a loan. Depending on the circumstances, improper handling of a gift can result in substantial tax penalties. With loans, be aware that any interest you collect is subject to taxation.