Article
Lending money to family and friends is a delicate subject. Given the current economy and tight credit standards, people are turning to friends and family for loans, and investors may be more willing to lend considering low interest earnings on bond investments.
Most people have some experience with lending { or being lent } money. These experiences can range from awful nightmares to wonderful memories. Ask yourself a series of questions, and document these decisions together to help ensure both parties have a pleasant and rewarding experience. Some questions to consider in your decision include whether you can afford to lend the money, how the loan may impact your relationship, why the person needs to borrow from you and not a bank. and the actual purpose of the loan. Before you decide to lend, ask yourself the following:
Do you have money to lend?
The first decision is whether you have the financial capacity to lend money. Can you easily live without the money you are lending for the term of the loan? Make sure you have a solid emergency fund of three to six months of expenses available before considering lending money to others. Consider your current investment portfolio. The loan could replace a portion of your bond portfolio, and provide cash flow to you. Intra-family loans are more attractive for investors considering the current low interest rate environment. The interest income generated from a loan could be more than you would receive on a bond investment of the same amount. Loans are usually less expensive and provide more interest income than bonds, while maintaining an attractive interest rate for borrowers. Talk to both your financial and your tax advisor about the financial implications of lending money.
Will the loan impact your relationship?
The relationship you have with the friend or family member is important. When you lend money, you may have to have tough conversations about payback. If you do not receive loan payments on time, will you feel comfortable asking for the money back, and holding the individual to the terms of the loan you agreed upon? If lending money is going to impact the relationship negatively, then you may want to consider helping the individual in other ways.
Why is the person asking you for a loan?
You are taking a risk of whether or not you will be paid back. Clarify why the borrower cannot obtain financing. Ensure that the person will be in a position to pay you back – if that person has had trouble paying back money to a bank, and you feel paying the money back could be a financial stretch for him or her, then lending may not be the best idea. Asking questions may protect you from the risk of the person’s defaulting on the loan.
What is the purpose of the loan?
For example, if you are loaning money to someone trying to start a business, ask to see a business plan and discuss projected financial statements. You want the business to succeed, and creating a business plan and thinking through the financial implications is important for success. Or, if you are loaning money to help someone purchase a home, make sure that the agreed-upon payments can be made without straining the individual financially.
If you decide you can comfortably live without the money, you want to help the person, and the borrower is in a good position to pay you back, take these few additional steps to have conversations together, agree to the terms, and document the agreement:
Think of yourself as a bank. Create safeguards that the loan and repayment plan will work for both parties. Have tough conversations on the front end and agree to the terms of the loan together. Create a loan agreement to detail the amount of the loan and how much interest will be charged and paid { annually, quarterly, daily }. Include details on how and when the loan will be repaid. Set expectations and steps for how late payments are handled. Include any fees for late payments and how those fees will be calculated and charged. Also, state what happens ii the loan is not repaid. Both parties will need to keep records of payments to avoid any discrepancies and to report any interest income to the Internal Revenue Service on tax returns. There may be additional documentation depending on the type of loan.
Many people consider co-signing a loan as a way to lend money. When you co-sign a loan you take on the obligation to pay that loan ii the borrower defaults. You should be careful when deciding to co-sign a loan because the loan will essentially be signed as if you obtained the loan on your own.
While taking these steps does not guarantee you will have a pleasant lending experience, creating a collaborative agreement and setting expectations together encourages a more favorable outcome. II disagreements do arise, both parties have the loan agreement and records to reference, which is important for maintaining the communication between both parties.
Lending money can be a good experience when you are helping people you care about achieve their goals. You can help someone who may be starting a family with the purchase of their first home, or you might help a friend or family member achieve their dream of starting a business.
