Here is the situation: My mom's friend of 30 years asked to borrow $40,000 to buy a house to fix up and then rent out. The total cost of the house was $340,000. They (friend+friend's husband) couldn't get a loan from the bank because the condition of the house wasn't good enough. So they used a home equity line of credit (on their primary residence, I think) for $300,000 and asked my mom for $40,000. It was "such a good opportunity that they couldn't pass it up."
The friends have two other rental properties (which also have mortgages on them). They've had them for about 3 years and have been doing well so far (according to my mom). My mom thinks it's a bad idea, that they're going to be stretched too far, but she still agreed! She said she couldn't say no to her friend of 30 years who's never asked for anything before. She felt like if she said no, she'd lose a friend. (I don't agree with this at all, by the way...)
My mom and I are close and we talk about finances all the time. She's pretty savvy. I'm shocked that she did this without consulting me. I finally figured out that she probably didn't consult me because she knew I'd tell her not to do it. She basically admitted to it.
The bottom line: She already sent the check. She won't take it back. I said that she needs to draw up a contract and have it signed and notarized. She asked me to write one up and she'll ask them to sign it.
- They agreed that the friend would pay back the loan in 1 year with 8% interest. (My mom says that's better than she can get in the stock market. I say $3200 isn't worth the worry of losing $40,000. She isn't actually worried though, just me...)
- She has an email from the friend stating: "I will borrow $30,000 to 40,000 from you and pay you back in one year with a 8% interest. when I received the money, I will send you a receipt (acknowledgement)." (My mom initially wavered between 30k and 40k but ended up lending $40k.) However, I don't think this is enough. I think there needs to be a more formal contract.
- She trusts the friend completely. She thinks there's 0 possibility of the friend trying to swindle her or intentionally not paying her back. But the risk is if something goes wrong, the housing market tanks, etc. My mom thinks the worst that could happen is that the friend can't pay it back in one year, that it takes longer than a year. She thinks they could pay her back out of their salaries.
- Friend lives 400 miles away.
- Mom is in her late 50s. She is doing ok for retirement, has less than most Bogleheads, but she'll have a pension. She said if she doesn't get paid back, losing a friend will hurt more than losing $40k. I don't think she can afford to lose it though. She is also helping my sister out financially.
- She told her friend that this would be the only time she would give them a loan.
- I got her to promise to consult with me on any large loans or just anything like this in the future.