Personal Loans: Was Shakespeare Right?

“Neither a borrower nor a lender be,” Polonius tells his son Laertes in Hamlet. “For loan oft loses both itself and friend.”

Shakespeare was speaking of personal loans – to friends and family members. Had he been a business writer he might have said: “Be a lender but only if thou likest the interest rate and thou gettest good collateral. And be a borrower only when thou haveth a good and safe investment to put it towards.”

Maybe not in those words.

But let’s talk about lending and borrowing to and from friends and family members. Is it a bad idea?

Borrowing can send a message of weakness: “I am not capable of managing my finances properly. I lack something you have.”

Borrowing also introduces into personal relationships an element that shouldn’t be there: financial dependency. The best personal relationships are those in which each party is strong and independent, both emotionally and financially.

Borrowing brings with it (or should) a level of stress. You have to manage not only to pay back the loan according to the terms provided, but also to restrain yourself from letting the financial issue cloud the relationship. This can be difficult.

Lending can be just as bad. It can make you think less of the borrower – especially if you don’t get paid back or get paid back too slowly. And if the borrower is a friend or family member, that’s a very significant cost.

Plus, if that were not risk enough, there is a very real chance that the borrower can end up resenting the transaction. And, instead of appreciating you for your kindness, feel offended by the obligation that came with it.

More than several times, I have gotten the distinct impression that friends (and even a family member or two) who owed me money eventually became angry about it.

So what do I do?

I follow half my advice. I have never borrowed money from friends and/or family members. Okay, that’s wrong. I have occasionally borrowed money for the movies when I forgot my wallet. And that was humiliating. Plus, now that I think of it, I don’t believe I ever paid back any of that money. And I can’t even remember who the lenders were.

See what I mean?

But I have lent, and still do lend, money to friends and family members.

Most of the time, it has been a very positive experience. The borrower has appreciated the loan and has been good about repaying it. As a rough estimate, I’d say it’s been an 80% positive experience for me with friends; 100% positive with family. (Then again, I have a very responsible family. You may not.)

In the beginning, I made mistakes. Because I lent money frivolously – acting like the money was nothing to me – I communicated to my borrowers a very irresponsible message: that I was rich and they weren’t. And, therefore, they didn’t have to take the loan seriously.

I should have known better. This may not be true for most people, but for me, if I can make someone I like happy by giving them money, I’ve always been inclined to do so. Still, I was naïve and didn’t fully understand the consequences of what I was doing.

However, going through those awkward and embarrassing (and sometimes hurtful) experiences did teach me to treat personal loans seriously. So nowadays when a friend or family asks for a loan, I do it in a way that both provides help (if it can be usefully given) and also, and more importantly, protects the relationship.

The first thing I do is explain that I no longer personally provide loans. I do it through my family’s LLC. This has three benefits. It eliminates my tendency to just say yes. It lets the borrower know that he’ll be borrowing not just from me but from my family. And it signals that if the loan is granted it will be executed in a formal way.

“Let me ask you a few questions,” I say, “and then I’ll take it to them.”

I ask the questions I’d ask if I were a banker considering a business loan. I ask about the purpose of the loan. I ask if they may be borrowing too much or too little. I ask about collateral and how they intend to pay off the loan.

Then, before I bring it to my family, I ask myself if there is any chance that they will approve it.

If the answer is “no way”: I ask myself if I am willing to simply give this person the amount of money they are asking for as a gift, with no expectation of getting it back. I do this because, sometimes, it’s just what I want to do. I know they won’t or can’t pay me back and I don’t want that to ruin our relationship.

The key consideration is this: Do I now or will I think less of this person for asking me to give them this loan?

I have to be honest with myself. I don’t want an unconscious objection to the request to become a lingering resentment in future years.

If the result of that self-interrogation is positive, I bring it to K. I made the mistake in the past of considering such personal gifts mine to give. But K, as my wife, owns half of our wealth. So she deserves a say.

If I think the family WILL approve the loan: I bring it to them. And in 9 cases out of 10, they do.

Only then do I get back to the person and tell them the good news. But at that point, since they know the request has been run by the family group, they are not surprised when I tell them that they will be signing a legally binding loan agreement with an arm’s-length interest rate, a repayment schedule, and (if possible) an attachment of some sort of collateral.

As you can imagine, responding to a loan request in such a way has come as a surprise to some who have requested loans. Having little or no experience with money, they have come to me expecting to do the deal with a handshake.

But I’ve found that this has been a great opportunity to teach them an important lesson that I learned many years ago from JSN, my old boss. When I asked him for a loan and he responded by asking me to sign a formal loan agreement, I was shocked. I thought he was being sort of greedy. He told me, “I’m not doing this for the interest. I can make more in any one of a dozen ways. I’m doing this to teach you the value of money.”

You probably don’t have a family LLC to act as a buffer between you and friends/family who come to you asking for a loan. So how can everything I’ve just said be useful for you?

If, like me, you are inclined to help people you care about by loaning or gifting them money, develop a response/procedure that will allow you to do it without endangering the relationships. If you aren’t so inclined, you can simply “be not a lender,” as Polonius advised. After all, these are personal – not financial – relationships that we’re talking about here. If they are worth having, they should not be dependent on your money.