The Smart Way to Lend Money to Family and Friends

Are you thinking of making a loan to relatives or friends? Learn about the various legal agreements that may be used to put the loan in writing.

What you will discover:

Is it lawful to lend money?
Can I charge interest on a loan I make to a friend?
Should I avoid lending money because of the risk of getting into legal trouble?
How can I be certain that I will be reimbursed?
Is a formal agreement truly required for a loan?

When purchasing a large asset or starting a business, many people seek loans from friends and family. Lending to relatives and friends is a high-risk venture with nothing to gain for the lender other than the gratification of aiding someone you know. When it comes to giving money, even to relatives and friends, one of the most repeated refrains is “get it in writing.” There are valid reasons to get a loan agreement, also known as a Promissory Note, in writing, but you may have additional concerns about lending money to someone you know. The following are some often asked questions and answers concerning lending money to relatives and friends.

Is it lawful to lend money?

It is, indeed. Lending money is lawful, and when you do so, the loan becomes the borrower’s legal duty to repay. If your borrower does not pay on a lesser loan, you may take legal action against them in small claims court. This may seem harsh, but it is critical to comprehend right away. A loan between family members has the same legal weight as a bank loan.

If you are lending money to a friend or family member, you should have the information in writing and have everyone sign it in case there is a disagreement or misunderstanding. If all you have is a verbal agreement and a handshake, it may not be enough to show the terms of your agreement. A signed, written contract is preferable than a handshake.

Can I charge interest on a loan I make to a friend?

Yes, you can, but the tax implications can be complicated. If you had put the money in an interest-bearing account, you would have earned interest on it, which is one solid reason to charge interest. Casual lenders, on the other hand, may unknowingly incur themselves tax difficulties if they do not arrange their loans correctly, obtain all of the facts in writing, and get the written agreement signed. If you wish to set up a loan arrangement with interest, you need consult with a lawyer.

Should I avoid lending money because of the risk of getting into legal trouble?

It all depends on the situation. Lending money to relatives or friends may swiftly sour the connection. Take into account your financial condition, relationships, and goals:

Can you afford to keep this money locked up?
Do you really want to take on the risk if other lenders have turned down the borrower? What if the borrower encounters unanticipated difficulties?
Are you and other members of your family prepared to go to court in the event of a default?
Are you willing to forgive your borrower’s debt in order to maintain the peace?

If losing this amount of money will cause you substantial financial damage, you should say so and decline the loan. If you decide to proceed, you should include the stipulations in a written and signed Promissory Note.

How can I be certain that I will be reimbursed?

While there are few guarantees in life, here are some suggestions that may increase the chances of being paid in full.

Tip 1: Write down the terms.

To record the specifics of your loan, you may use a legally binding and simple to fill out Loan Agreement or a Promissory Note. Of course, a stated pledge between friends is simpler and more emotionally delicate, but the problem arises when one or both parties cannot remember the terms a year or two later. A written agreement prevents an awkward dispute later on. If a problem arises, the agreement may contain a solution that was previously agreed upon. There are several forms of personal loan agreements, so it may be useful to study your alternatives or consult with a lawyer to choose which arrangement to employ.

Tip 2: Outline all important loan agreement provisions.

Avoiding uncertainty by making your loan conditions as explicit as possible. Consider include the following:

The names and addresses of the agreement’s parties.
Amount of the loan (principal).
The interest rate.
Terms of repayment, including due dates and any late fees or penalties.
Signature phrases.

The repayment terms may be tailored to the borrower’s specific situation. For some debtors, two smaller payments each month, for example, may be preferable. Alternatively, if the borrower anticipates a significant financial boost, such as a tax refund, a lump-sum repayment may be appropriate. In any event, you should explicitly state the due date or payment conditions.

You may also describe the loan’s collateral and, if appropriate, whether the loan obligation is transferred to a third party.

Tip 3: Specify your remedy in the event that the borrower fails.

If the borrower defaults or fails to make payments, you may:

Change the terms of the agreement to reflect changes in circumstances.
Take any collateral that was provided to secure the loan.
Go to court to get a ruling.

Is a formal agreement truly required for a loan?

While there may be limited legal recourse if an unwritten loan is not repaid, it can be costly and difficult to enforce. You may cover the legal fundamentals

If you have a written loan agreement, you will have a higher chance of being paid back if you have a problem with your borrower. You may be able to avoid court with a written agreement by renegotiating loan conditions, recouping a part of the debt in a settlement agreement, or assisting the borrower in obtaining a debt consolidation loan.