Wealthsimple is a whole new kind of investing service. This is the latest installment of our “Dear Ms. Etiquette” series, where our columnist untangles the issues that happen when people and money get together.
Dear Ms. Etiquette:
My sister, who I love, who I'd bury a body for (theoretically), who is, you know, my sister, wants to adult and buy a house. But she only has half the down payment. So guess what? She asked me to loan her the rest—and I'm conflicted! Does it make me a jerk that I'm a little freaked out about mixing family and, like, debt repayment?
The Bank of Big Sister
Dear Ms. Bank,
No, you’re not a jerk. Well maybe you're a jerk—I don't know you!—but it's pretty normal to feel weird about mixing money and family. Money carries with it all kinds of gnarly emotional seedlings—guilt, status, resentment, feelings of security. We have enough of that stuff tied up in our families already, who needs more? Hey, how about making your relationship with your sister way more complicated than it already is, put it at permanent risk, and possibly lose money along the way? Anyone who unthinkingly says yes to that is either a saint or a lunatic. And it's OK if you're neither.
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The hardest thing about a decision like this is that there are so many questions and issues and conundrums knotted up in it. I'm going to do my best to take them one at a time so you don't have a panic attack. The idea is to pinpoint what it is about the decision that's making it hard—and then deciding if it's a voice you want to listen to, or not. To help, I talked to an expert: Dr. Mary Gresham, a financial psychologist (it’s a thing!) practicing in Atlanta.
Step One: Act Like a Bank
The first thing to do is ask yourself a series of questions, not about you, but about your sister:
Does your sister have a history of making tragic financial decisions? If the answer is yes, you are allowed to skip to the section near the bottom where we discuss how to delicately give her the hard pass.
A corollary: by giving her money are you fueling something self-destructive in her? Addiction, the inability to care for oneself, etc.? If the answer is yes, again: head to the how-to-say-no part.
Do you believe she can pay you back? If this answer is no, and that's not OK with you, scroll down.
And even if she does seem like she'll have the resources to make good, you'd be wise to remember that all loans are to some extent risky. So it's important to know the answer to this: if for some reason you don't get that money back, can your finances sustain that kind of loss? Remember this saying which I’m shocked Urban Outfitters hasn’t slapped on a cropped t-shirt yet: never loan money you can’t afford to lose.
Step Two: Now Act Like an Emotional Bank
OK, step one is done. Good job. Now it's time to answer a couple questions that are a little more about you.
How do you plan on handling being a creditor? When you grab a drink together to bullshit about the weird stuff your mom does on Facebook, are you going to get mad (internally or externally) that your sister is ordering imported beer when Miller is on special—“If it’s good enough for dad!” ? In other words, are you going to be able to not make everything about the loan? Can you keep the creditor part of your brain separate from the sister part of your brain? If the answer is no, ask yourself if you can change. Still no? Scroll to the bottom.
Now think about it the other way: how will your sister react when she's not just your sister but a debtor. “The person borrowing can feel beholden or self conscious,” Dr. Gresham, the psychologist, said. “Money is very emotional to us and also very symbolic.”
In other words, there’s a high probability things will get weird. Talk about this with her.
How do I actually say no to someone I would theoretically give a kidney to?
Step Three: Make an Actual Plan
OK, you've made it through all the questions, you've come to the conclusion your sister is a fairly responsible person who hasn't secretly maxed a dozen high-interest credits cards from Pottery Barn and the Gap, and you want to entertain the idea of loaning your sister the dough. Gresham says the next step is sitting down for a brutally honest heart-to-heart that includes laying out the precise terms of the loan. If the terms of this thing aren't laid out clearly and dispassionately—like a bank would!—you're asking for trouble.
“You need to have a long, detailed conversation about the risks and benefits of lending,” says Gresham. “Then spell out the timeline and the expectations. For example, do you expect to be repaid before she takes vacations or makes other discretionary expenditures? How confidential is the loan, i.e., will others know about it?”
The most you can give someone as a gift tax-free is $15,000 per year–so if the amount is larger than that, and you want to avoid taxes, you must charge interest so that it qualifies as a loan instead of a gift. (You should probably get your CPA involved for any loan over $10,000 anyway). Start by consulting the IRS Applicable Federal Rates, or AFR. To charge interest, you can still charge rates that are far lower than a bank's. Another good reason to charge interest is that, if you're not paid back, you can deduct your losses from your taxable income—if it's a gift you can't do that, though you will need to report the interest you make as income.
Charging interest also solidifies something important for both the lender and borrower: this is a formalized business agreement that requires follow through. Plus, setting up a formal loan, even if it's a principal only loan, will automatically create a payment schedule that will keep all parties honest.
Whatever you do, make sure you put your agreement in writing. Think about using a company like LoanBack, which specializes in formalizing loans in a legally recognized contract among family members.
Step Four: How to Say No
This is what a lot of people are wondering when they ask this question: how do I actually say no to someone I would theoretically give a kidney to?
If you decide you can't make the loan, your goal should be to, you know, avoid turning your relationship into an emotional dumpster fire. Here’s a tip: don’t start with, I’m really not a jerk! Don't be defensive. Lead with the truth, or a softened version of it. Tell her why it’s not feasible for you to be without this money now—maybe you're paying off your own debt for instance, or you're worried about job security, or trying to save for a big purchase. Tell her you’ll be there for her in other ways that may help her save cash, whether it’s giving her a ride to work so she doesn't have to lease a car or maybe even paying for an accountant to help her get her finances straight. Gresham says offering alternatives—like non-bank marketplace lending companies Loanback and Prosper can also be helpful.
"If you're dealing with money dysfunction, there are lots of other ways you can support someone you care about," says Gresham, "that don't involve you giving them money directly."
Step Five: Be Willing to Say Yes Anyway
Consider this story: a friend of mine just borrowed a small amount of money from her dad to buy a house when she moved back to her hometown and neither of them followed any of the rational advice above. When I asked her if it was awkward, as a 40-year-old grown-ass woman, to ask her father to lend her part of the down payment, she said, “the weird thing was, we didn’t even talk about it.” “He just kind of grunted and mumbled, ‘well, I’ll help you out.’ Do I think he was thrilled to write the check? Not exactly,” she told me. “But I do think he was happy to be in a position to help his only daughter achieve a life milestone.”
In other words, as much as lending money to a family member can make you feel uneasy, remember that helping someone you love can feel pretty rewarding. And even if it doesn't, there's always the value of a good implicit guilt trip: my friend's dad gets to come over uninvited to the new house (that he helped her buy) every Saturday morning looking for coffee, and that loan means the only thing my friend should say about it is, “You want some almond milk in that?”
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