Lending to family and friends can be fruitful

NEW YORK (Reuters) - Lending money to family and friends can be profitable -- and it doesn’t have to lead to hard feelings.

People are very willing to lend to the ones they love, but they want to be paid back. Increasingly, they are turning to financial advisers for help.

One adviser helped a husband and wife make money while financing their daughter’s graduate studies in physical therapy. Another helped formalize a $10,000 loan between friends for a therapeutic dance studio.

A close personal relationship between lender and borrower can help guard against default, but advisers say they also must prepare their clients for bad news.

In the case of the graduate school loan, both sides benefited: The parents offered a $22,000 loan at 6 percent interest, far below the 11 percent their daughter would have paid on a private loan, and a better rate than the parents could earn from money market funds or bank CDs.

“That’s where the biggest bang for the buck is -- the school loan rates are high on personal loans, and my clients, on their safe money, are not getting much of anything,” said Carolyn McClanahan, the parents’ financial adviser.

The 26-year-old’s parents made clear they expected their money back.

McClanahan, of Jacksonville, Florida-based Life Planning Partners Inc, vetted the daughter and the deal, arranged a notarized promissory note, and set up a $500-per-month repayment plan beginning six months after the daughter graduated.

McClanahan advises 35 families and has about $30 million under management. A former doctor, she specializes in advising physicians. She said she has formalized about two dozen relationship-based loans in the past six years.

NO FAMILY FEUDS

Lending money to friends and family can be one of the fastest ways to derail a friendship or sour family feelings, so many lenders are turning to financial advisers to formalize loan terms and steer them to sound investments.

“It can be very risky and it really boils down to whether the lender will exhaust all remedies to be paid back or not, if that’s going to be an issue,” said Raymond James Financial Services Inc adviser John Sirois.

Sirois, who is also an attorney, said he has averaged several relationship-based loans each year for the past decade. Most have been to purchase homes, finance small businesses, or consolidate debt.

Sirois is based in Houma, Louisiana, and has 95 clients and about $30 million under management.

Advisers say it is important to be clear what the relationship-based loans are not: they are not gifts, and they are not going to help build a borrower’s credit rating.

Private loans must charge interest to legally be considered a loan and not a gift, which is taxed at a higher rate.

Milo Benningfield, who helped arrange the dance studio loan, said borrowers often turn to friends and family if they are not considered “qualified borrowers” by professional lenders.

He said relationship-based deals can work to a lender’s advantage.

“If you borrow from your parents or from a friend, preserving that relationship is very important. Unless you lend money to a psychopath, most people will really want to work hard to pay you back somehow, some way, and that’s a huge piece of protection,” Benningfield said.

An attorney, Benningfield has about $48 million under management and advises 23 families through his San Francisco-based Benningfield Financial Advisors.

Defaults are still possible, and the consequences of default could prove far worse than simply losing the money invested.

Besides ensuring their clients will not be financially wiped out by default, advisers must also prepare them emotionally.

“I always prepare them for the chance of loss and always ask them: ‘If they don’t pay you back, how is this going to affect how you feel about your child?’” said McClanahan.