One of my tennis buddies told me a funny story about borrowing money from his parents. He was 28 at the time and asked for a $30,000 loan to buy a condominium. Since his parents had the spare cash and weren’t making much from interest, they figured lending money to him was a win-win situation.
All was going well until one day, his mother came over to his newly purchased condominium. It had been a while since they moved in and his mother wanted to have a talk about the lent money.
The mother said, “Paul, your father and I are disappointed in you. It’s been three months since you borrowed our money to buy your condominium and you haven’t paid us anything back. What is going on?”
My tennis buddy replied, “Mom, I had no idea you wanted to get paid back so soon. We’ve been busy furnishing the place and stuff. I guess we should have written down some parameters regarding how you would get paid back!”
Then his mom replied, “Yes, you should have been more considerate about paying us back something every month. We worked very hard for this money and it was supposed to be for our retirement. However, your dad and I talked about it and we’ve decided to forgive the $30,000 loan as a wedding present.”
This is when my friend said he almost burst a capillary in his forehead, “No mom! After the guilt you just gave me, there’s no way I’m accepting your money!”
He then stormed to his room, made some calculations, and gave her a check that paid back some interest and principal. There was no way he would let his mother lord over him like that. He was pissed.
Borrowing and Lending Money From And to Friends And Family Is Tricky
I’m not a fan of borrowing money from friends and family. Money can often make for some weird power dynamics. It can also create resentment, distrust, and unhappiness.
Most of the time, I’d rather just work more and wait longer than borrow money from friends. Meanwhile, I want my parents to enjoy as much of their wealth as possible during their golden years. They are frugal and need to start decumulating more assets.
The more you value your friendship, the more careful you should be with borrowing money from your close friends. You don’t want to lose them!
However, if your friendship is truly great, then borrowing money might be absolutely fine. Your best friend might be more than happy to lend you money because they want the best for you. If they can earn a higher interest rate, then everybody wins.
I know that if a great friend needed to borrow money from me, I would lend it in a heartbeat. Depending on the amount he wanted to borrow and what he wanted to borrow the money for, I might even just write it off as a gift.
I feel like I’ve won the life lottery, so I’ve tried to make it my mission to help out as many friends and family by spreading my lottery winnings. Whether it’s by regularly sending my in-laws money or by giving my parents my Uber Eats account to use as often as they want, spreading the wealth feels great! It’s like creating multiple lottery winners!
It’s much easier to financially help people you know rather than people or organizations you don’t. But that’s my next goal in giving as I enter my decumulation phase.
When Borrowing Or Lending Money From Or To Friends Is OK
I realized something interesting about when borrowing or lending money from or to friends is OK. The determination is based on the amount of money borrowed or lent as a percentage of the lender’s net worth.
If a friend asks to borrow $10, you’d probably have no problem lending the money. The lunch truck only accepts cash because their Square payments machine is broken. You’re probably happy to just buy them lunch.
However, if your friend asked to borrow $10,000, you might start asking questions, like what the hell for?! $10,000 is a weird amount of money to borrow because it’s not enough to buy a car or a house. But it is enough to buy a lot of things you don’t need, such as a fancy watch or a family vacation to Hawaii at a nice resort.
Now imagine if your friend asked to borrow $1 million to buy a house. He needs a bridge loan because he found his dream home and his liquidity is currently trapped in his existing home. He eventually plans to sell the home to pay you back, but it will take time.
Would you lend him $1 million? Most would probably say no.
But what if you had a net worth of $50 million and you have $20 million sitting in cash earning 0.1% interest. You’ve clearly got a top 1% net worth.
Lending $1 million is only 2% of your net worth and 5% of your overall cash reserve. Your friend is also willing to pay you an interest rate equal to the 10-year bond yield, a rate hundreds of times higher than your current interest rate. He would set up an automatic monthly electronic transfer and make it simple.
Given he’s your best friend and you are confident he will pay you back, maybe you might just do it. You earn more interest and your friend gets what he wants, a win-win.
The Benefits To Borrowing Money From A Friend Or Family Member
Let’s quickly discuss the benefits of borrowing money from a friend or family member. They are:
- Usually a lower interest rate than what a bank would charge. You could get a personal loan from a lending marketplace such as Credible. The rate will be much lower than what you would pay to a credit card company. However, it will be much higher than if you borrowed from your friend.
- Easier to get a loan because you don’t have to go through a bank’s underwriting process. It can take 30-60 days on average to get a loan from a bank.
- Access to the money more quickly.
- Potentially access to a greater amount of capital than what a bank would lend.
Now let’s move on to the lender’s point of view to determine how much money to lend to a friend or family member. The benefits of the lender are earning a higher interest rate and helping a friend or family member out.
Goodness knows the average money market interest rate is pathetic.
How Much Money To Lend Based On Net Worth
The lower the percentage a loan makes up of your net worth, the higher the propensity you have to lend to your friends and family. I’m also assuming that you would never provide a hard money loan to a non-friend or non-family member. Instead, you would just invest your money in a traditional channel to try and make a return.
The question is, what should the loan’s limit be as a percentage of your net worth? As a lender, you must always assume a certain level of default risk. Further, if your friend or family member fails to pay back the money, you must decide what is the most amount of money you’d be willing to lose while keeping your relationship intact.
Let’s talk through the percentages of loan-to-net worth to figure out how much to lend to friends or family members.
10% Or Greater Loan-To-Net Worth
When it comes to investing in speculative assets, such as cryptocurrency, NFTs, or penny stocks, I recommend limiting your investments to at most 10% of your investable assets. This way, if your speculative investments go to zero, you still have 90% of your investable assets left. However, if your speculative investments become 10 baggers, they will move the needle on your returns.
Since most people don’t have 100% of their net worth in investable assets, lending out 10% or greater of your net worth is very aggressive. Further, the returns likely won’t be massive since you’re limited by the interest rate you can charge to a friend or family member.
The most you could charge would probably be 1-2% above what a bank would charge for a personal loan, business loan, or mortgage. However, most of the time, you would probably lend at a lower rate than what your friend or family member could get elsewhere so they could benefit. Otherwise, it would seem like you’re taking advantage of them.
Meanwhile, you are also benefiting since you are getting a higher rate than you would get from a typical money market account or even a CD.
Lending out 10% or greater of your net worth to a friend or family member is much too much. Therefore, I don’t recommend doing it.
5% Loan-To-Net Worth
Lending out 5% of your net worth feels like the upper limit of how much you should ever lend to a friend or family member.
Let’s say you are worth $1 million. $600,000 is tied up in your home, $300,000 is stocks and $100,000 is in cash. Lending out $50,000 sounds like the maximum amount of money to lend. With this amount, the interest income isn’t significant. But it does feel good to optimize your cash.
Even if you were more liquid with $400,000 in cash and no investments, it’s probably best to limit your loan to 5% of your total net worth. You’ll survive losing $50,000 if your friend doesn’t pay you back.
Losing 5% of your net worth in a stock market correction is par for the course. In a bear market, you could easily lose 35% of the value of your investments. But if you do lose 5% of your net worth to your friend or family member, you are going to feel some resentment.
Therefore, I don’t advise lending up to 5% of your net worth to friends and family either.
1% Loan-to-Net Worth: The Safe Lending Amount
If you’re lending out 1% of your net worth or less to a friend or family, you’re fine no matter what happens. Nothing in your life will change if you lose 1% of your net worth. If your friend doesn’t pay you back or takes a much longer time than agreed upon to pay you back, no big deal.
Let’s say you have a $10 million net worth, $6 million is tied up in real estate and $4 million is in liquid investments like stocks, bond funds, and cash. Lending $100,000 to your best friend for even the most unnecessary reason, like buying a Porsche 911, isn’t a big deal. You could probably have fun driving it too!
Although, if he starts showing off his new car online and completely ignores the covenants of his loan, then you might get pissed off. If you are to borrow money, keep it low key.
If your friend needed to borrow $100,000 to pay for a medical emergency, of course you would lend that amount in a heartbeat and probably much more. The purpose of the loan is an important determinant.
Don’t Lend More Than 2% Of Your Net Worth To Friends And Family
There’s a lot of gray area between lending 1% to 10% of your net worth to friends and family. I say have a hard limit of lending no more than 2% of your net worth to friends and family.
The 1% to 2% spread will take into account:
- How close you are to that friend or family member (the closer you are, the closer to 2%)
- The probability that friend or family member will pay you back (the higher the probability, the closer to 2%)
- The interest rate your friend or family member is willing to pay (the higher the rate, usually the closer to 2%)
- How liquid your net worth is (the more liquid your net worth, the closer to 2%)
- The urgency of using your cash for some other purpose (the less urgent and fewer ideas you have for using your cash, the closer to 2%)
The 1% to 2% loan amount to net worth spread works as your net worth grows.
Of course, if you are a billionaire, you can afford to lend an even greater percentage of your net worth and you’ll still be fine. But who is really going to borrow $10 – $20+ million?
Average Interest Rates For Savings, Money Market, CDs
Below are the average deposit rates for savings, interest checking, money market, and certificates of deposit according to the FDIC. The rates are always changing.
As you can see below, the average deposit rates are pretty low, even after rates have risen aggressively since 2021. Therefore, as a hard money lender, you could do much better.
Set Up Clear Loan Covenants For Lending Money
If you plan on lending out money or borrowing money, clear and strict loan covenants should be made. The contract should have:
- The interest rate and when the interest rate will change (fixed or variable based on an index)
- Whether the loan is amortizing over the course of the loan or an interest-only loan with a bullet payment at the end
- The payback period
- Penalties for late payment or missed payments
- Collateral for the loan
- How the loan gets paid (physical check, electronic, in cash, in stocks, etc)
Thanks to technology, it’s easy to receive payments from anybody. It’s simple to send money through Paypal, Zelle, Venmo, or wire transfer.
As a landlord since 2003, the evolution has gone from receiving physical checks to receiving mostly automatic online payments at the beginning of each month. In fact, my new tenants sent me their deposit and first month’s rent from the East Coast.
Lending money can be a tricky situation. However, if you are a charitable person with a large enough net worth, lending money can work out just fine.
Just make sure to follow the guidelines and write out a clear contract that both parties agree upon. The last thing you want to do is ruin a good relationship.
Questions And Recommendations
Readers, what do you think about lending money to friends or family? What is the maximum amount of money you’d lend to a friend or family? How would you come up with the interest rate and other loan covenants? Do you have any examples where lending money turned out great or poorly?
If you’re interested in properly tackling other big financial and life dilemmas, pick up a copy of my new book, Buy This, Not That: How To Spend Your Way To Wealth And Freedom. I go through the logic to help you make optimal decisions for a better life.
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JJ Gonzalez says
I once lent 10,000 to a friend who was afraid his new wife would see that his credit cards were maxed it. He bought sport memorabilia with the money. So like someone earlier said I owned my own business and this friend was one of my vendors so he must has assumed that I had a money tree in my back yard because he never paid me a dime. Well it’s 20 years and I am still waiting NOT FOR THE RETURN OF THE MONEY, but simply a call to say I got in over my head and I just can’t pay you back. But I have lent to friends relatives and employees over the years. You can’t make people have manners that is their parents job
If your personal net worth is over $1million and you are flush cash, give gifts less than $10k, as opposed to loans, to family and friends. Otherwise, without a solid contract and a monthly pay back plan, you may set yourself up for disappointment and frustration. My wife and I believe that when we have the ability it’s better to simply bless someone with the gift and hope they too can see how rewarding gift giving is to the giver.
Jeff S says
I have done personal loans to small businesses and real estate investors. Usually 7-9%. Always worked well.
Loans to family haven’t worked out too well. However, I really looked at them as a gift. I would ask about repayment a couple times and then just let it go. It is not worth getting worked up about or ruining a family relationship.
Al Corrupt says
Don’t borrow (I actually did once for a home down payment from my dad) and only lend as much as you are willing to lose. If you’re willing to lose it, it shouldn’t keep you awake.
I haven’t had the occasion to lend to any family or friends, and having seen so many negative outcomes, I think I would only ‘lend’ to someone an amount (likely several % of net worth) who I would be willing to give as a gift and not have any guilt in my mind/heart. That’s a tall ask, and I can’t imagine.
Maybe if a friend had a sick child and needed $10k to get to an out of pocket max for a health plan? If I knew it would be a struggle or would send them into credit card debt, and they were in a tough spot, maybe something like that would be a situation I’d ‘lend’ the money, but also be totally fine just forgiving the debt if it became burdensome and would never hold it against them. There may be some other situations but that’s one I can imagine.
Outside of that, I really would not want to be involved in any consumption related debt… buying a house, car, whatever. Go to a bank, and leave me out of it. I’ll come check it out and be excited with you, but not letting a loan on something like that get in the way of our friendship… and maybe to my earlier ‘rule’, not a chance I would be okay forgiving a loan for a purchase like that!
Caroline at Costa Rica FIRE says
We have done really well with private lending — both as borrower and lender. We have easy to follow contracts that spell out loan term, interest rate and payment plan (typically short loans that are interest only or no payment till maturity). As a borrower, we have used these private/ friends & family loans for real estate investing, so we can come in as an all-cash offer and then refinance to pay back our lender. As a lender, we have used these loans to have a steady 10-17% interest rate on some of our assets (we keep it to less than 10%).
Financial Samurai says
Oh wow, 10-17% interest rate is high. How long do the borrowers borrow for? That seems really hard to make a return if they are borrowing to buy real estate or whatever.
While I do not make loans to family or friends, for over 10 years I have been making Private Loans to Real Estate Investors who are primarily “rehabbers” or “Buy and Hold” investors. These loans are “Asset-based”, so my loans are never more than 65-70% of the After-Repair-Value of the collateral.
The key to these deals is that my Borrower finds off-market properties that are distressed or owned by distressed owners. He/she buys at a deep discount with cash borrowed from me – the closing frequently happens within 5-10 days of finding the property and making the deal. Rehabbers upgrade the property (think HGTV) and repay me when they sell the rehabbed property at a profit. Buy and Hold investors do a light rehab to get it rent ready, rent it for a few months to have a track record when they go to a bank for conventional financing and re-fi to pay me off. The benefit to the borrower is borrowing 100% of the cash needed for the project and having FAST access to that cash.
The benefit to me is that I make 10-15% interest on these loans, with 1-5 points. Rates are determined by my assessment of the risk, but 12% interest and 3 points is my most common rate, with repayment in 6 to 12 months. I currently have >$600K (~20% of my investable assets) loaned on 5 different properties. I’m confident I have made at least 60+ loans over the past 11 years and only 2 have not paid as agreed.
I’m retired, so this supplements our retirement income. But equally important is the fun that I have meeting with people, doing the deals, celebrating their success as they build their investable asset base while improving the neighborhoods where these loans are used. A Win-Win for ALL!!!
I am very intrigued about how you lend money to friends/family for real estate investing. I don’t want to assume but I am thinking you have a real estate business/investing business? I would like to learn more about your business and how you loan money with interest and it sounds like this has worked out well for you. Could you explain more about what you do and how you lend money with interest. I loaned two friends each $5k this past year and neither has paid me back. I think I am going to have to charge interest to get any money back. Very interested and need advice. Thank you so kindly.
My personal experience with lending is acting as the banker for my kids College Student Loans.
My philosophy at this time was that my son’s would do better in school if they had some skin in the game. I told them all I would subsidize their college education, but not pay for 100%.
In doing so, I took out many Parent Student Loans and passed these through to the students over time along with my contributions. All graduated with business and economic degrees but so far only one has paid back and the other two are partially paid or delinquent.
I feel this kind of loan to family members was part of a parents contribution to help insure their financial success as they transitioned into the working world.
Payback in this case would be nice since we are now in retirement and could really use the additional $100k outstanding. I had a tongue in cheek agreement with my kids that if they did not pay me back, I would come and live with them when I got old. I was hoping this would be additional incentive for a more timely payback. I am still hopeful but not sure extra cash late in life would be useful beyond long term care scenarios.
On two separate occasions I lent $40,000 and $30,000, respectively to two friends. The one I lent the $40,000 to was using it to consolidate many loans she had but she was a hardworking determined person and she paid me faithfully each month, as much as she possibly could, and she paid it off with interest in a few years. I was happy to have helped her out, she was always extremely grateful and said so again and again. The other person who I lent $30,000 to was a childhood friend. I should have known better. She was drowning in bills and credit card interest. Suffice it to say, payments began strong but eventually fizzled, and I think I got about $20K total from her but in my mind she still owes me $10K. However, the dynamic is such that, even though we had the same background, both college educated, I worked myself to the bone all my life to save and invest and she always had some “whoa is me” excuse as to why her life was difficult. Anyway I quickly realized I as the lender became demonized, and she looked at me like “you are wealthy, you can afford it, I’m struggling”. So anyway I can confidently say that I will NEVER AGAIN lend money to a friend. If they need it I will give it to them as a gift.
Financial Samurai says
Ah, getting demonized for landing money just because you have more of it is such a shame. You helped them! And now you are getting blamed? Terrible.
A Financial Samurai, like a Lannister, always pays their debt! Otherwise, dishonor to the family!
Ny Money Hawk says
Personally, I don’t like the idea of lending to friends and family members.
Exception being the small amounts for convenience lending for a friend, like buying the concert tickets and they pay you back for example.
If they needed money, I would consider giving it to them depending on how much, what they needed it for, and how close a friend or family member.
For a friend I probably wouldn’t lend or give money. But for a very close friend I could see myself possibly giving 1-2% of my net worth if there was an extremely compelling reason. But it would have to be a really unique circumstance.
Like in 10+ years when my daughters are adults and not on my health insurance, if they had an important medical need and couldn’t pay I would pay whatever it took. But if they wanted to borrow money for a round the world trip I would say no.
Hi, I’ve done this many times and have two outstanding loans to two friends right now. But, I’ve done this via my LLC and had a strong contract on one large ($300K) loan as well as a revolving LOC ($15K) to another friend. I never talk about the deal when gathering together as a friend, and keep the business side very separate. The deal has worked for both sides as it has helped them tremendously and provides me a higher passive rate of income (3.5% fixed) than a bank. I’m titled on a piece of real estate on the big loan and the little one is based on our word/bond of over 40 years of friendship. Certainly if the little one is lost, then it’ll not affect me in the least (except for the friendship). But, the practice has worked for me and I intend on continuing with this approach as needed. Goof topic!
Wow! I am in a career and I would love to have my own business along with my career since I love it. You must own your own business correct? I have loaned 2 friends money not as much as you, but both $5k. I now know not to loan money to friends without your type of contract. I will have to get an LLC and begin my side business (photography and blog but not sure how to make money off of my blog – that will be more research of course on my part.). I guess my question to you is with your LLC – business correct? How did/do you keep it separate? If you loan someone through your LLC aren’t they obligated to pay you back since it is through your business? If the other friend does not pay you back then could you or would you go through legal channels? Thanks.
Great topic. Another thing to be careful about is lending money to love interests. My aunt got swindled into lending over $50,000 to a man who was pursuing her and a couple months later he disappeared along with the money. So sad.
The most I ever lent was about $500 to a family member. It was supposed to be paid back but as more and more time went by I gave up and finally verbally said I forgave the loan.
Giving with no expectations is ok when you’re willing, but lending with the hope of getting money back can be quite a slippery slope that often ends with nothing back in return.
Financial Samurai says
Ugh. That pisses me off. Using love to swindle people is the worst. But it just goes to show how much finding true love means to so many people.