Loaning out money is always a pretty risky proposition for the individual. Banks and other types of lenders have the right idea; they require a good credit history, collateral, and a signed contract before they’ll hand over the cash that borrowers seek. But when your friends or family come to you with their hands out, you’re not very likely to ask for any of these things. And this is why people who lend money rarely see it coming back to them. So should you lend money to your family and friends? That’s for you to decide. But if you do, you should definitely go about it in a manner that will help to ensure the loan is repaid. And you’d better be prepared for the potential repercussions if the borrowers should fail to hold up their end of the bargain.
The first thing to consider when you receive a request for money is whether or not you can afford to lend it. If you absolutely don’t have the extra cash on hand or you’re going to need it back in short order to meet your own financial obligations, DO NOT lend it. That said, you’re welcome to do whatever you want with your disposable income, including lending it out to your loved ones in their hour of need. But if you’d like to see a return you must be smart about who you lend to and the terms of the loan. For example, if you have lent money to someone before and they haven’t paid you back, for goodness sake don’t extend them any more credit!
If you decide to pull the trigger and hand over the cash, there are a couple of things you should strongly consider doing. First, create a written agreement. It doesn’t have to be fancy; a simple IOU will do. But there are two reasons you’ll want to make the document a bit more detailed. The first is taxation. If you loan a decent sum you could be on the hook to pay a gift tax, even though the money was a loan. The only real way to avoid this is to lend less than the amount that would be taxed (currently limited to $13,000 per year, per recipient) or to produce a document showing the borrower’s intent to repay with interest. Even if you only charge 1% per year, it may be a necessary addition to the contract in order to avoid having to pay the IRS for the privilege of loaning out money. The second reason to create a contract is just in case you have to go to court in order to secure repayment.
And it is for the latter reason that you will also want to include a schedule for payments in your agreement. From there all you have to do is create two copies of the contract for each party to sign, and if you really want to tie it up with a bow, take it to a notary public to witness. This may seem like a lot of work for a simple loan between friends, but when it comes to money, nothing is simple. Sadly, even with an agreement in place you could end up losing personal relationships if the party in question fails to repay. So your best policy is not to lend in the first place, or else just give your money away with no expectation of repayment.
Evan Fischer writes for a number of online publications in the finance sector reviewing loan sites such as Wonga.com and many online comparison websites.