When you’re lending money to friends, family and loved ones, it helps to have some form of legal protection, or formal agreement, in place to protect your position. This will give you a clear recourse if things do go wrong, and allow you to get your money back without needing to have difficult conversations later down the line. Let’s take a closer look:
Why it’s challenging to lend to loved ones
Lending to friends and family can be taboo. It’s great when you can help, but this type of lending involves trust, emotion and commitment. It can also be difficult, meaning that certain key issues are not discussed and clarified before the loan starts. Financial experts always advise that you ensure your own financial well-being first before helping out friends and family. Ask whether you can actually afford it, and then ask if they can afford it. If your friend or family member is borrowing from you because their own spending is too high, and they are already damaging their own credit record, then you may never see the money back. If that person isn’t working, how will they repay you? What are their financial commitments and what do they earn? Make sure you have the facts before agreeing to a loan.
Protect yourself with documentation
If you do decide to go ahead and lend to a family member or friend, then it helps to have documentation in place that clarifies the terms of the arrangement, in the same way that any commercial lender would. A loan agreement formalises the arrangement.
1. Set terms
Agree how much you will lend, whether you will charge an interest rate and how much, and for how long you are lending. Document how much you expect them to repay each month. Agree on these conditions before you hand over any money.
2. Draw up the agreement
Document a written loan agreement which details the terms and provides a date and signature to the agreement in case there is a later dispute. You and the borrower should sign this agreement with two independent witnesses present. This sends an important message to the borrower that the money is not a gift — it is a loan which must be repaid.
3. Make the transfer
Only transfer the money when the terms have been agreed upon and the loan agreement has been signed. Do this by bank transfer so that there is a record of the payment. Add a recognisable reference for further evidence.
4. Manage repayments
Ask your friend or family member to set up a standing order for the agreed amounts and ask them to send evidence that this has been done. Keep a record of all repayments so that you are both clear on where the payment schedule is up to at any time.
With a structure and agreement in place, you can set yourself up for success if you do decide to lend to friends and family.