Photo: Robert Trachtenberg
Everyone faces tough financial situations—sooner or later, we all find ourselves short on cash and in need of a favor. But just as not every gift is truly generous, neither is every loan. In fact, there are times when lending a loved one money hurts more than it helps.
When someone close to you asks to borrow money, make sure you consider why they're asking. Are they in a temporary bind and in need of a bridge to get back on track? Or is there a chronic shortcoming in their money management skills that they're asking you to be party to? Sometimes the most thoughtful gift is to say no: No, because you're unwilling to enable their poor habits. No, because they need to save themselves. No, because giving what they're asking for could erode your own financial security.
If you do decide to say yes, make sure both you and the borrower are clear on the transaction's particulars. A loan must be treated as a business deal, even if you're lending to a member of your immediate family or your dearest friend. Prepare a written contract—it can be a simple one-page promissory note—that details the terms of the loan, including the amount they're borrowing, the interest rate, and the payback period. You can download a basic promissory note at Nolo.com.
You should also think carefully before cosigning a loan—no matter who is asking. Cosigning is a huge financial commitment: If the primary borrower can't keep up with the payments, you're guaranteeing to the bank that you'll step up and take responsibility for the debt yourself. And make sure you fully understand the effect this obligation can have on your credit. If the borrower is 30 days late on a payment, there will be a 30-day late payment on your credit report, too.
Ask yourself why the person needs you to cosign. Is it because she has lousy credit? That's a major red flag. Or is the lender asking for a cosigner because of the large loan amount? For example, is your recent-college-grad son trying to land a car loan beyond what his salary can safely cover? If so, your parental job is not to cosign but to help him see that he needs to shop for a cheaper car.
If you do cosign, feel free to attach some strings. Ask for proof that the payments are being made on time—have the borrower set up an automatic payment from her bank account each month, and then have a confirmation of the payment sent to you. You've given the borrower a tremendous gift, and you deserve the gift of peace of mind in return.
Next: How to give generously and intelligently
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Suze Orman's most recent book is Suze Orman's Action Plan: New Rules for New Times (Spiegel & Grau).
From the December 2010 issue of O, The Oprah Magazine