When money is tight, family and friends are often called upon for a loan. It’s nice to help people but lending money on an informal basis can be a recipe for disaster. Here are some of the problems that could arise:
- You may not be able to enforce repayment and if problems occur, your relationship with the borrower may become very difficult
- You may end up in the same situation as the borrower if things go wrong
- You may have to declare any interest as income in your tax return
- The borrower may use your money for a different purpose than what you lent it for
- The borrower may already have a large amount of debt that they are struggling with
- The borrower may die, become seriously ill or have a relationship breakdown before they repay you.
If you are convinced that you need to lend the money, here are some tips to ensure things have a better chance of going smoothly:
- Get to know the true financial situation of the borrower
- Ensure the money is used as agreed, for example by making the payment directly to the third party
- Ask for evidence that other options for borrowing have been explored
- Don’t lend money you can’t afford to lose
- Have a written agreement signed by all parties to record the purpose and amount of the loan, the rate of interest, the frequency and amount of repayments, the time frame for repayment and how late payment will be dealt with
- Encourage the borrower to make repayments by regular automatic payment.
Money is easily replaced – relationships with good friends and family are not. Lending money to people you know should be done as a last resort and with extreme caution.