Posted on March - 21 - 2011

The Ugly Underbelly of the Personal Loan

Over at “Surviving and Thriving,” Donna Freedman recently blogged about her experience lending money to a friend. Her post resonated with me as I have had a similar experience. So while we talk a lot about different types of loans in the world of personal finance–be it car loans, mortgages or payday lenders–we often neglect to discuss one of the most common lending practices: the personal loan.

Ben Franklin is quoted as saying, “Neither a borrower nor a lender be” and I’m inclined to agree with him. I’ve been on both sides of the coin and it’s not an easy situation to be in. Having borrowed $5,000 from my father to help fix up a newly purchased condo, there was always an undercurrent of judgment. Although I do remember laughing when my father visited me post renovations and looked down at my shiny, new hardwood laminate funded by his money and said, “Hello, floor!“

Still, I was mighty happy to pay off that debt.

On the other side of the equation was the time I lent over $500 to my hairdresser whose husband had gone off on an alcoholic binge and had left her with two small kids and only half the money she needed to pay the rent. Her mother had died earlier that year and she really had no other support system–emotional as well as financial. I couldn’t stand the thought of her and her little girls getting evicted so close to Christmas, so I pulled out all the cash I had on hand plus wrote her a check for $500 so that she could pay the rent.

She was overwhelmed and extremely grateful and I felt good about helping someone in need. Soon after that, I found out that she’d used my funds not to pay the rent but to buy Christmas presents for her kids. Her rationale was that her father had convinced her to bring the kids and visit him and he’d give her money to cover costs, rent, etc. He didn’t. I must admit I was really disappointed to find out that a month after propping her up financially she was in the same shape or worse. It also didn’t help to find out she’d purchased an iPod shuffle for her six year-old. I personally can’t justify expensive electronics purchases for a young child–especially when one is in financial crisis mode.

You have to keep in mind that at the time I was only working part-time, living in a studio apartment and basically living without much of a safety net myself. I tried guiding her to find support programs like free school lunch and daycare programs as well as cutting back on unnecessary expenses (when money is tight, the cable package needs to be the first thing to go), but found it difficult to comprehend some of the choices she was making.

Therein lies the ugly underbelly of the personal loan: it’s difficult not to resent the borrower when they’re making stupid spending decisions with YOUR money.

Although I’d tried to see loan as more of a “gift,” it would have been easy enough to recoup my funds back via monthly hair stylist services. In fact, my hairdresser/friend would have been able to pay me back in barter in less than a year. Unfortunately, she moved and never responded to my attempts to contact her about 4-5 months after I’d given her the money. I suspect that she’d reconciled with her erstwhile husband and was too embarrassed to let me know given all the nasty details I knew about their break-up.

Tallying up the losses I was out $500 and one hairdresser and friend–as well as taking a huge hit to my trusting nature and generous instincts. Although it’s been said fairly often, here are some things to keep in mind when lending money to friends and family:

  • Never lend more money than you can afford to lose.

  • Go into the situation with the mindset that the money is a gift rather than a loan so that you’ll be pleasantly surprised if it’s repaid rather than bitterly disappointed if it’s not.

  • If the borrower needs the funds for a specific purpose–like rent, tuition, car payment–consider making the payment directly to prevent the funds being used for another purpose.

  • If it’s a substantial sum, consider drawing up a simple agreement outlining how and when the funds are to be repaid.

  • Don’t feel guilty about saying, “No.” If you can’t afford to make a personal loan–whether it’s a lack of money on your end or lack of faith that it will be paid back by the borrower–politely decline to do so.

On the other hand, if you are in the position to request a personal loan from a friend or family member, here is what you should remember:

  • Review your finances and make sure there aren’t places where you can cut back before asking for a hand-out. It’s not cool to ask someone to help you cover your rent when you’re paying for premium cable package, trips to Las Vegas and personal training sessions.

  • Use the money for its intended purpose (pay rent, mortgage, car payment, etc.) only.

  • Make sure you have a plan to pay back the loan in a timely fashion–with interest–and stick to it. There are few things that can strain a relationship or ruin a friendship than an unpaid debt.

  • Consider alternatives to asking those close to you for a loan. Can you trade-in that sports car or luxury vehicle for an economy model? Sell off some gadgets or trinkets? Find a part-time gig to make some extra money? Asking for a loan certainly requires a combination of courage and humility, but it’s always better to see where you can take ownership of your finances rather than be beholden to others.

Even though my hairdresser friend never asked me to loan her money, I still feel more than a little peeved that there was never any goodwill effort on her part to repay me. This experience will in turn affect my decision with regard to loaning money to someone in the future.

Have you ever had a bad experience with loaning money to a friend or family member? Or have you been on the other side of the fence and needed to ask someone close to you for a personal loan? I’d love to hear how it worked out for you.

Stella Louise is the editor of the Savings.com Blog & Save, a lifestyle blog for savvy consumers that offers a variety of ways to save money as well as tips on how to live well and while spending less.

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