Episode 4: Questions to Ask Before Lending Your Hard-earned Money.
According to Chron, before banks loan out money to you, the five critical factors they look out for include: Character, Collateral, Capacity, Capital, Conditions.
You have to be very specific about how much money you need, what you will do with it and how you will pay it back. Without these conditions in place, your loan will be denied.
As a private lender, you may not necessarily need all five of these conditions nor be very particular about enforcing them, but you need to find a way of letting your debtor know that you value your money and that you are interested in getting it back.
To achieve this, there are certain questions you must ask and obtain answers to before going ahead to open your wallet as a potential lender.
Chiara Fucarino, in an article on lifed.com by, had an horrible experience with two family members she loaned money to. When she confronted them and tried to reason with them, they got defensive and hostile.
Though she was $2000 poorer, she learnt an important lesson:
“Always be smart and evaluate everything carefully before doling out a cent to anyone who hits you up for money.”
She went on to assert that the best way to make a smart money-lending decision is to ask the following seven questions.
1. Why Does This Person Need Money?
Banks don’t loan out money without knowing what it’s being spent on, so why should you? You might be worried about hurting your family member’s or friend’s feelings, but you should never blindly hand over funds just because someone “needs a few dollars”. It’s your money, so you have every right to know what the money is for so you can decide if it’s worthy of a loan.
When hit up for a hefty amount of cash, ask the person for all the details about where the money is going. If he refuses to spare any important information, take that as a huge red flag and don’t give him anything. If he complies and gives you all the information you need, do your homework to ensure that your loan is going to be used wisely.
For example, if a friend asks you for a thousand dollars to help pay off her car loan, find out how much she has to pay each month and whether or not she will be able to pay off the rest of her car loan.
The last thing you want is for your friend to put your money towards her car payments, only to have the car repossessed in the end because she couldn’t come up with any more money to pay off the rest of the loan. Your generous loan would be wasted, and there might be a high chance you would never see the money again.
2. Are There Other Options?
Often times, when asking you for money, a person might try to make you believe that he has depleted all his options before coming to you. Sometimes it may be true; sometimes it may be false. Talk to him and find out if he already tried to get a bank loan, dipped into his IRA, or explored all the other money borrowing options available to him.
You can also find out if there are other ways for you to help. In most cases, money isn’t the only solution. You can offer service-based assistance.
3. Can I Afford to Lose This Kind of Money?
With the economy falling apart, more and more people are weaseling out of repaying their loans.
If you’re lucky enough to end up with a borrower who’s actually responsible enough to pay back her debt, she’ll be likely to put her money towards interest-based loans by financial institutions before she gives you a dime. It’s because she has a lot to lose by not paying her mortgage or student loans (she’ll be at risk of foreclosure or bad credit, respectively) while the only thing she’ll lose by not paying you back is your friendship.[Can you now see why it is easy to lose a close relationship when a debt goes bad?]
If you give out a personal loan, you might never see the money again. You have to ask yourself if you can handle losing this much cash. Would you go about your day without realizing that the money’s gone, or would it break you financially?
4. How Well Do I Know This Person?[I already shared this point in the last episode where I mentioned that you should never lend money to someone you barely know.]
Before lending out a large amount of money, make sure you know the borrower’s background. Is this person a new friend or lover, or is he someone you’ve known for a long time? Is this person a habitual borrower (or even worse, a moocher) or is he a responsible and trustworthy person?
Do your research. Ask mutual friends or family members if they’ve had experience lending money to this particular person. Ask them whether or not they’d advise you to do the same thing.
5. Does This Person Have the Means to Reimburse Me?
Evaluate this person’s money situation. Does she have any kind of income? Are you confident that she makes enough money to repay you?
Also evaluate the loan itself. If the person only needs $100 to pay for a parking ticket, she’ll probably repay you right away or after a short period of time.
However, if she needs $3,000 to catch up on her mortgage payments, she’ll have a much harder time paying you back and will probably end up not reimbursing you the full amount.
6. How Will this Loan Affect My Relationship With Other People?
Not only will this loan affect you and your borrower, it may also affect other people. Do you have a spouse or a partner who might get upset over the loan? Do you have other friends or family members who might feel that you’re favoring this certain person over them? Take the time to think about how going through with this deal will impact other people around you.
7. Can I Distance Myself?
The worst part of lending money to someone is feeling the need to constantly monitor that person’s spending habits. I was guilty of this when I lent the money to my two family members. I obsessed over how they spent the money, and I ended up harboring ill feelings towards them. It’s not healthy to question the borrower’s every move and get upset every time he goes on a vacation instead of repaying you.
Ask yourself if you’re able to separate yourself from the money and focus on repayment only. If you can’t distance yourself, you should think twice about lending the money. It’ll bring you nothing but misery.
Also, ask yourself if you can afford to have a strained relationship with this person. If you’re not reimbursed, your relationship with this person could go sour.[You have to brace your mind for any kind of attitude the borrower will put up as an excuse to avoid paying you back. If you anticipate this scenario, you will be less surprised when it happens and it will be easy to move on with your life.]
8. What Are The Chances of Getting This Loan Back?
This is perhaps one of the hardest question to answer because it has to do with making a calculated prediction.
When lending money to people especially family and friends, you should know that the chances are because of the relationship, they will take repaying it lightly. This means that the chance of getting your money back from these people is very slim. And this knowledge will inform your decision on the amount to give, the terms and conditions to put forth and the intensity of your follow-up.
9. Can I Condone Their Asking For More Money?
Your borrower may use the foot-in-the-door technique without you, or even them, realizing it. The foot-in-the-door is a psychological compliance tactic which involves getting a person to first agree to a small request because later the person will be more likely to comply with a larger request.
Your friend may first lay the groundwork by asking to borrow a relatively small sum, such as $10. But after you have agreed to lend them the smaller sum, you may become more open to lending a larger sum if then return for more next time. Once this cycle starts, chances are it may not stop. Your friend now sees you as a “reliable” friend to go to when they’re financially strapped. Usually, this hardly ends well.
If you suspect this might happen, then you have to make it clear at the start that you are not going to be their “go-to lender” next time because you may not be always disposed to lend.
10. Will I Need This Money Soon?
Nobody has the power to foresee the future. As such, if lending money to your friend requires you to take money out of your emergency fund or savings, don’t do it.
These funds are there to ensure financial stability for you and your dependants. What if an emergency comes up like health challenge, accident, retrenchment, police case or a contract goes bad and you then need to rely on your emergency savings fund?
Under such circumstances, every bit of money will count and when it is not readily available you’ll begin to regret lending that friend. As a last choice, you may find yourself going a-borrowing. Hence, it’s best you keep your money for your own rainy days and instead provide friendly suggestions to your friend on how to better manage their finances.
To wrap up, when you loan your money to someone, you do so as an act of goodwill, and would never want to the borrower to betray your trust, but life is not always that simple and straightforward. Something beyond the borrower’s may happen. Also, you cannot expect everyone to be as honest and responsible as yourself.
It is for this reason that you should never, ever dole out a big loan out of fear, guilt or sense of moral obligation. Always trust your instincts. If you feel uneasy about going through with the deal, just remember that it’s okay to say NO. It’s your money, after all!
Be honest. Explain why you’re not going to hand over the money. A true friend or a loving family member will understand.
In the event that you find your borrower responsible and trustworthy enough to take out a big loan from you, how do you say yes and protect yourself? How do you ensure you keep your debtors on their toes so they won’t disappoint you?
Watch out for answers to these questions and lots more in the next episode as I delve into how to hold your debtor accountable.
I want to believe this episode added a lot of value to you. What do you think about these questions and their power to help you make better money lending decisions?
I would like to know your thoughts, questions, contributions and suggestions in the comments below. Don’t forget to share with your friends.
N/B: The first 7 questions shown above first appeared in this article by Chiara. Comments from me are enclosed in [square brackets] within the article. The last 3 questions are mine.