Financial advisors always warn against lending money to friends. But what if you’re the one who needs the loan? Is it ever a good idea to borrow from or loan money to friends? Here’s what you need to know.
However, if your friend is in a sticky spot, helping them out could seem the right thing. But before you agree to hand over any money, there are several things you should consider.
Here are some tips for lending money that will make it easier for both of you.
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Lending Money to Friends: The Do’s
The following are some rules to help make lending money to friends easier.
1. Agree on the loan terms
Make sure you and your friend agree on the amount, the repayment date, and the interest rate before you lend money. Having a formal contract drawn up is unnecessary, but it’s a good idea to send an email outlining particulars if there is any chance of this friendship ending.
If you don’t have an agreement, you could find that your friend isn’t inclined to pay back the loan or that they only repay small amounts.
2. Write up a contract
After you and your friend agree to the terms, it might be helpful for one or both of you to draw up a formal contract. This could include information such as the amount of money, the interest rate, and repayment details (for example, month by month, end of year).
This will help to avoid any issues if you and your friend stop talking to each other for any reason.
3. Charge interest
If you are loaning money to your friend, it’s a good idea to charge interest on the loan. Setting interest lets you know this is a business transaction, not just a favor.
By charging interest, even if it’s just one percent per year, you are less likely to be out of pocket when the loan is paid back.
Lending Money to Friends: The Don’ts
The following are some rules for lending money that you should avoid.
1. Lend without a backup plan
If you aren’t confident about your ability to keep up with commitments, it is best not to lend money.
If the worst happens and they can no longer afford repayments, be aware that this could harm your financial situation because friends should only ever loan if both parties are financially stable enough for such a commitment.
2. Assume they can repay you (without proof)
Another lending mistake is to loan money for no reason other than because you’re friends. This can be dangerous if you are not prepared to follow through with the repayment process.
For example, if your friend doesn’t have access to money or is struggling financially, that doesn’t necessarily mean they will repay you.
3. Lend to someone without a stable income
To avoid lending money, your friend will struggle to repay. It’s a good idea to look into their financial situation before offering a loan.
For example, does your friend have a job? If so, how much do they earn? Knowing this information will help you determine whether or not they can repay the loan.
Give them money to pay bills/food/rent.
Instead of lending money, offer to pay for what they need directly. For example, if your friend has a utility bill that is past due, offer to pay it in exchange for a promise to repay you in full in the next few weeks.
This is better than lending them money because you give them what they need when they need it. This also helps you avoid unnecessary financial stress if they cannot repay you in full later.
What happens if my friend doesn’t repay my loan?
If your friend cannot repay your loan, there are several options.
For example, you can reach an agreement between the two of you, or you can take them to court for repayment if that fails. While this might seem a drastic step, it can be necessary sometimes.
When taking your friend to court, be prepared to provide evidence that the loan agreement was formal, making it difficult for your friend to dispute.
However, it would be best if you tried to seek repayment without going to court first. In many cases, this works, and you avoid the costs of a lengthy legal battle. Even if going to court is your only option, you should try all other avenues before doing so.
If they don’t have money, they can offer a different type of repayment instead of cash, such as helping with chores around the house or yard work.
If all else fails, you can always write off the loan if it is clear your friend will never be able to repay you.
To avoid writing off a loan later (which could harm your friendship), it’s best to get repayment in small steps while keeping track of any expenses for this specific loan.
As a last resort, you could always sell the item back to your friend if it is in good condition and they still really want it. This can be a fair way of recovering some of your money from the initial loan.