How to Safely Lend Money to Family and Friends
We hear all the time that you should not loan money to friends, but yet friends and family are the most important parts of life. So what do you do, when a family member or close friend has nowhere else to turn for their financial needs? If you feel like you can't (or don't want to) say no, there are some steps you can take to make sure the loan doesn't turn into lingering hard feelings. At the very basic level, it's important to get everyone (spouses, significant others, etc.) on board before you make a deal, consider the impact of this decision and try to look beyond the loan.
1. Lend Only What You Can Afford to Lose
Despite the best efforts of everyone involved, there is a risk you will not be repaid on your loan. It's a good idea to go into this with the mindset that you will not see the money again and then decide how much you are able to loan. Getting the money back may happen more slowly than planned or not at all since the borrower is likely "high risk" if they are turning to you rather than getting a personal loan from a bank or credit union because they have bad credit. (You can check your own credit scores for free on Credit.com.) So it's important to keep that in mind and be ready and willing to forgive in the worst-case scenario.
2. Keep It Professional
There are two ways to handle this - one is to not ask any questions about where the money is going and not worry about it. This can be hard if you then see the person making what you feel are financially irresponsible decisions. The other is to know exactly where the money is going -- whether it's to fund the down payment on a home, pay off credit card debt or something else. While it may seem awkward, you have the right to know where your cash is going so you can decide if this is a worthy loan.
Joking and avoiding details is not part of the negotiation -- be sure you are open about the details like the amount being loaned, formal repayment method and schedule, interest rate and possible late fees right away to avoid future miscommunication and confusion. And, of course, get it in writing. Often overlooked but extremely important, you want an agreement with details and signatures so both parties are clear on the contract. This should include consequences for late or missed payments.
3. Charge Interest
It may seem unnecessary to expect family and friends to pay interest, but it is the fairest way to protect yourself. If you are loaning out a big amount of money, you could be earning interest through investments or even a savings account. A fair interest rate will inspire your borrower to pay back in a timely manner and help you avoid gift taxes. While the exact percentage is up to you, I suggest you charge a competitive rate that borrowers could get from a traditional lender while maintaining the guidelines from the Internal Revenue Service.
4. Communicate Regularly
Having a plan is integral to the process, but it cannot always account for every possible situation. It's a good idea to let the borrower know from the onset that you want them to come to you if they run into trouble with payments. You may want to set up weekly or monthly phone conversations to discuss financial health and loan progress. While proactive and transparent, this also keeps your relationship from being overshadowed by the loan -- normal activities together do not need to be dominated by the talk of finances since you have a specified time to go over that.
Remember that if you are not comfortable or financially able to lend, you can say no. Don't let guilt guide you into unsafe personal financial conditions. It is nice to help when you can, but it is always your decision and one you should make carefully.