Lending money to family and friends may seem like the best way to avoid the costs associated with borrowing from banks and other sources, but it can cause lasting damage to some of the most important relationships you’ll ever have.
For that reason, it’s certainly something to consider carefully.
There are a number of advantages and disadvantages associated with lending money to your nearest and dearest, but if they really need some extra money, it might be the only option you have. With that in mind, it’s important you do it right.
The South African lender Wonga recently produced a guide to borrowing from family friends, but we’re here to add to that with a checklist to help you get it right.
Here are a few things to tick off lending to family and friends:
1. Only deal with cash
If a family member or friend wants to borrow money then you should only lend them physical cash or make a bank transfer. Allowing them to use your credit card to make a purchase puts you at risk that their actions could impact your credit score affect your ability to borrow for years to come.
2. Only lend what can you afford to lose
When lending to family or friends, you should only let them borrow an amount you can afford to lose. If the money isn’t repaid, you need to be sure it won’t impact your ability to live comfortably, pay bills or go on holiday etc.
3. Consider the potential impact
Before reaching an agreement, it’s essential you consider just how the loan could impact other family members. Could you be accused of favoritism? Will it drive a wedge in other relationships? What happens if they default – will you be willing to forgive and forget?
4. Understand why the money is needed
You need to think carefully about why they need the loan before agreeing to lend them the money. Not everyone spends money wisely. If the money is to fund a new outfit or a holiday then think twice about your decision. If they are reluctant to tell you what they’ll spend the money on, that’s a sure sign it’s not a deal you should agree to.
5. Discuss the terms
Never hand over the money before you’ve discussed the interest they’ll pay; you should at least charge the rate of inflation to protect the value of your money. You should also clarify when the full amount will be repaid, how much will be repaid every week or month and the consequences of a missed repayment.
6. Get it in writing
Last but certainly not least, you need to get all of the details in writing. While a verbal agreement is considered legally binding, it could be much more difficult to prove the debt if it’s your word against theirs. Having a written agreement in place gives you the peace of mind that if it does come down to it, you have irrefutable proof of the agreement you reached.
What are your experiences of lending money to family or friends?
Please share your thoughts in the comments below.