Mellody Hobson: Balancing Family and Money

July 18, 2006 — -- Whether you should lend money to a family member depends upon both your relationship with that family member and whether you can afford to do it. If you decide to move forward, be sure to set very clear guidelines right from the start and do not let the informality of your family relationship disguise the seriousness of the loan.

What if you need to borrow money? Is it best to go to family first? How should you approach it?

If you need to borrow money to get through a tough financial time or start a new business, you need to carefully consider the pros and cons of going to a family member. While there may be fewer roadblocks than going to a bank, money and family do not always mix well. However, if you have poor credit or think it might be difficult to secure a loan, you may want to look to a family member for help.

For starters, go to someone who is in a financial position to lend you the money, and avoid asking someone whose finances are strained, as it will put both you and the lender in an awkward position. When approaching the loan, you need to provide a clear explanation of why you need the money and how you plan to repay it. Be very businesslike about the whole transaction, as it will give your relative confidence that you are serious about repayment and are not just looking for easy money.

Once the loan is made, be sure to stand up to your commitments of how the money will be used and when it will be repaid. If you realize that you are not able to repay as quickly as the time frame you originally agreed upon, go to the family member before he or she has to come to you looking for the money. Agree upon a revised plan -- which may include repayment in services instead of cash -- that you can realistically meet.

How do you set the parameters?

Setting parameters is extraordinarily important, because you do not want money to come between you and your family member, which happens more often than we would like. Before agreeing to lend the money, make sure you clearly establish the purpose of the loan. If the reason for the money is not clearly stated and the loan ends up going toward an extravagant new wardrobe or beach vacation when the lender was thinking it was to help a relative through a financial hardship, anger and tension will likely develop. As such, make the loan as official as possible by agreeing upon guidelines and putting them in writing.

You can easily draft a loan document yourself without the assistance of a lawyer. Just make sure to include the names of the lender and the borrower; the date of the loan; the amount of the loan; the interest rate, if applicable; the period over which the loan will be repaid; the amount of each payment; and the frequency of payments -- and both the lender and the borrower should sign this document to reflect the agreement.

What do you do if they do not pay you back?

It is important to address the issue head on. Sit down with your relative and take out the loan agreement you both signed previously and come up with a revised payment plan. Consider having the relative pay whatever he or she can, even if it is less than you originally agreed to -- something is better than nothing.

Alternatively, perhaps you can be repaid in services, such as baby sitting, yard work or care of an elderly relative. That said, to avoid problems down the line, at the front end you should think of your loan as a charitable contribution -- meaning you are giving money with a worthy purpose in mind and no expectations to get it back.

Ultimately, if you can afford to lose the money, let it go. However, I would advise against being the bank of second chance, so do not loan the person money again if he or he was unable to repay you the first time. At the end of the day, though, it is important to keep in mind that relationships are worth more than money.

Do we tend to have different expectations for borrowing/loaning money from family than from friends or a bank? Should we?

In most cases, the answer is yes. Many family members believe that the "family bank" is always open. In fact, oftentimes when a relative goes to another relative with a loan request, the person almost believes that they are entitled to the loan by mere virtue of the relationship, regardless of credit history or reasons for the loan. And when it comes to repayment there also tend to be different rules -- while a borrower would think twice about defaulting on a loan payment to a bank, the borrower may assume more flexibility with a family member.

Ultimately, again, it boils down to expectations. So long as both the lender and the borrower share the same set of expectations regarding when and if the money will be repaid, the situation should remain positive.

What happens if one family member makes much more than others? How should familial obligations be handled?

While money can certainly be beneficial in many situations, it is not the only way to help another family member. Time and resources can also be valuable. For example, if someone in your family does not have the financial means to contribute to the costs of care for an elderly relative but has time to contribute, that time can be just as significant a contribution as money. In any family, especially large ones, there are going to be discrepancies in income, so it is important take a holistic approach to see who can offer what -- whether it is time, brainpower or money.

Should you pay relatives for baby sitting? Watching an elderly relative?

I do think you should pay a relative for baby sitting or taking care of an elderly parent. If your family member was not taking care of your child or parent, someone else would be doing it, and most likely the person would not be doing it for free.

If you are able to financially do so, pay your family member the same rate you would pay a caregiver who is not a relative. If you cannot afford the going rate, pay whatever you can, because who better to care for family than family? Knowing that someone you trust implicitly is taking care of your loved one is priceless.

How do you handle situations when an irresponsible family member repeatedly asks for money? What is the best way to have a conversation about it?

First and foremost, you need to find out why this person is repeatedly in need of money, and it is important to do this as soon as possible. The longer you wait, the harder it is going to be to say no and the more reliant the person may become on your money. When talking to your relative, remind the person that you too have a budget to live within, and you cannot lend money endlessly. Simply tell the person that you have done all that you can do, and help them find a solution to their money problems that does not involve your pocketbook.

Mellody Hobson, president of Ariel Capital Management (arielmutualfunds.com) in Chicago, is "Good Morning America's" personal finance expert.