Lending Money to Friends and Family

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These economic times practically guarantee that someone you know (and possibly love) will come to you for money. Lending money to friends and family has always been fraught with problems. Indeed, there is always the chance that the debt someone else owes you could, in the end, cause a rupture in your relationship. While it might best in some cases to send your relatives and friends on their way, there are instances that you might feel necessitate offering a loan. Here are some things to keep in mind if actually do take the plunge and lend money to friends and family:

Make sure you can afford to part with the money

Rule #1 is to make sure you can afford to make the loan. Do you have the resources to part with the money right now, even if it is only for a short time? And, if you aren’t paid back for years — or ever — will you regret not having that money? It you have to take on debt, or sell assets you’d rather keep, in order to make a loan, you are probably better off not making the loan.

Charging interest

When you lend money to friends and family, the United States government requires that you charge a minimum interest rate. It can be as low as 1% if you want, but if you’re doing more than spotting your buddy a couple bucks, you need to charge some sort of interest. In an ideal world, you settle on an interest rate that provides you with a rate of return that is more than a corporate bond (a safer corporate bond), but less than the interest rate your friend or relative would get if s/he went to a financial institution. Oh, and you will have to pay taxes on the interest you earn from the loan.

Getting loan terms in writing

Whenever you engage in these types of transactions, it is best to keep things strictly business. Yes, some friends and family will be upset that you want to separate the business from the personal, but it really should be done. In any case, you should put together some sort of loan agreement. There are a number of loan agreement templates online that can help you get a feel for how to set it up. Your agreement should specify the amount borrowed, when it should be repaid, the interest rate being charge, payment schedule if applicable, as well as names and addresses of both parties, and signatures.

Alternatives to lending money to friends and family

Many people just aren’t comfortable lending money to friends and family. If you are not comfortable with the prospect of getting involved in that sort of dealing, there are alternatives. If you can afford it, you could perhaps present the needy person with a one-time gift (make sure they know it is one-time, and that you cannot afford to give more). Money magazine reports that 27% of those who lend money to family members never get it back anyway, and 43% aren’t paid in full. You can also buy a few extra groceries when you go shopping to free up some other money for your friend or relative. Purchasing gift cards to grocery stores or other types of stores is also a way to help free up some money for your struggling acquaintances, without having to commit large amounts of money.

In the end, you should help out as much as you feel comfortable. But if you decide to go the loan route, you can protect yourself by making it a business arrangement.