Loaning your hard earned money to a friend or family member can be a scary thing, especially since the reality is there’s a reason they weren’t able to obtain a loan from a more traditional lender like a bank. People who are rejected for loans from banks or private lenders usually have past or even present financial problems which are preventing them from getting the money they want and need. These issues make your friend or family member a high risk borrower. But since it’s probably a good friend or close family member that’s asking you for the money you’ll want to help them out. That’s why we’ve put together the facts you need to consider and the rules you should follow to enable a smooth transaction.
Choose a Good Cause
Lots of people have lots of different reasons why they need to borrow money, not all reasons are good or worth your time and money. Although it’s your money and your friend or family member, so you get to make the final decision, here are a few situations where your money won’t be going to waste and you’ll know you’re helping out someone in need.
- Invest in a new business or help grow an already successful one.
- Money to help with a down payment on a new home.
- Help someone out after a medical emergency or illness.
- Money to help a friend get back on their feet after a divorce or legal problems
- Helping out a person who’s new to the country.
Once you’ve decided to help someone out financially it’s a good idea to have a plan and set up a time to discuss all the details. They might be family to you but it’s still your money so better to be prepared than constantly worried and stressed.
Make a Plan and be Prepared
1. Loaning vs. Co-signing
Everyone has an opinion about the risk of co-signing a loan for someone who is unable to get one on their own, so it’s up to you to make the decision. Let’s put it this way, whatever choice you make the risk is all yours in both cases. If you outright loan the money then there’s always a chance you’ll never see it again. If you co-sign you’re still responsible for the entire loan, not just half. The one difference is co-signing a loan can have a negative effect on your credit score if neither of you are able to make the loan payments. Based on your own financial situation the decision should be obvious, just remember you’re helping out someone who probably really needs your help.
2. Discuss an Interest Rate That’s Reasonable
This can be a touchy subject but it’s definitely one that needs to be discussed and taken seriously. Since it’s you that’s putting up the money and taking on a certain amount of risk it’s completely reasonable to ask for interest. But don’t be surprised if your friend or family member objects, they might not have even thought about interest and therefore might not have budgeted for it. If this is the case have a conversation about it and explain your side of the situation, they’ll probably understand.
When it comes to setting the rate, be fair and reasonable. You’ll probably want the rate to be lower than one from a bank but still high enough that you’re making more money than if you left the cash in your bank account. Don’t forget about taxes as you might run into some complications surrounding gift taxes.
3. Get it all in Writing
This is definitely the most important step, getting all the details in writing. This is how you’ll be able to protect both yourself and the person who is borrowing the money. If you’re too scared or shy to ask for a written agreement then you might not be prepared to loan the money, collecting the payments when your friend or family member is falling behind will be far more awkward. You can always blame it on someone else, like your accountant. There are lots of online resources that provide free loan agreement templates that you can print out and have both parties’ sign. Make sure the agreement contains all pertinent information including the loan amount, interest rate and what will happen if a payment is late.
4. Organise an Official Payment Arrangement
Setting up an official payment plan is just as important as getting a written agreement and should be included in the written agreement. Decide how the payments will be made, when the payments should be made and what kind of late fees there will be. It’s up to you to decide if late fees are necessary but again, you’re taking on the risk of loaning your own money. A cheque, PayPal or an automatic bank transfer are your best options. If you decide to go with cheque make sure you keep a copy of them just in case there is a disagreement about past payments.
Lending money is serious business and should be though about carefully before a decision is made especially when best friends and close family members are involved. Treat the deal seriously and follow the same precautions that a more traditional lender would and your transaction should go as smoothly as you hoped.
