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The Best Ways to Loan Money to Friends and Family

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Loaning Money to Friends and Family

“To thine ownself be true,” may be some of the most repeated advice from Shakespeare’s Hamlet, but we also should not forget this advice from Lord Polonius:

Neither a borrower nor a lender be;
For loan oft loses both itself and friend…

In reality, most of us are fairly generous people, and we want to help a family member or friend with a loan when we can. The other reality is that a person who can’t borrow money from a traditional source (especially in today’s easy credit environment) often has damaged credit or no credit, both of which make such a borrower a greater credit risk.

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For the record, I believe that lending money to friends and family is far preferable to cosigning a loan for someone who can’t qualify on his or her own. CoSigning creates a false sense of security. You think the primary borrower is responsible for the loan, and that you as a cosigner are not. In fact, when you cosign, you are on the hook for the entire loan. Even if it is paid on time, your credit score will be affected by the loan if it is reported to the credit bureaus.

Warnings aside, there are times when you may be asked to loan money to someone you know for any number of reasons. These can include:

  • Capital to start or grow a small business;
  • A down payment or loan so your child or relative can purchase a home;
  • Money to help someone get back on his or her feet after a divorce, illness, or other catastrophe;
  • Helping a younger person or immigrant establishing credit for the first time.

If you are going to lend money to someone you know, you might as well increase your chances for success. Here’s how:

1. Set a Fair Interest Rate

This can work in your favor, as well as the borrower’s. The interest rate you charge can still be competitive with the rate your borrower can get from a traditional lender, but high enough that you make more money than you would if you parked your money in a safer bank account. If your borrower balks at being charged interest, you might want to blame it on the IRS. That’s because if you give person more than $12,000 in a year, it will likely be treated as a gift and subject to gift tax. To avoid this potential complication on a larger loan, you must charge an interest rate that is at least as high as the IRS’ Applicable Federal Rate, which is set monthly.

2. Get Your Agreement in Writing

If you think it is “uncomfortable” to insist on a written loan agreement, think about how uncomfortable you will be trying to collect if your borrower falls behind. If you have to, blame it on your spouse, accountant, or someone else who “insists you get it in writing.” You can find a sample promissory note online or in a legal forms book, or if the amount is large enough, you can ask an attorney to draft it for you. Spell out the terms, including how much is being borrowed, the interest rate, late payments and when they will be assessed, and how/where payments will be made.

3. Set up a Formal Payment Arrangement

Let’s face it: it will be easier for your borrower to make a late payment to you than to his or her other creditors. And I doubt you want to become a debt collector. So include in your agreement the details of when payments are due, late fees that will be charged, and how you want payments to be made (by check or PayPal, for example). I don’t recommend you accept cash. I do recommend that you set up a copy of any checks or money orders in a file in case there is a disagreement about payments that were made later. Go a step further to arrange automatic deductions from the borrower’s bank account to yours, and you won’t have to worry about whether the check is in the mail.

To learn more about how loans work and about best-practices for lending, read more from our experts by visiting our Loans Learning Center.

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  • Gars

    Why do you want to lend money to a person that a professional banker thinks is a bad risk?

    Just give them the money or be prepared to lose a friend. You might as well lose the friend now and keep your money!

    Would they be willing to lend you the same amount under the same conditions? That’s not even a question they can answer if they don’t have the money to lend to begin with.

    • dollarsmakesense 11

      I agree whole heartedly with everything that you say. With some people, pressure from spouses, family or friends tend to make one feel guilty for other’s own financial blunders. A lot of people are not talking to me anymore because I won’t contribute to their financial recklessness. I don’t give a damn because no one is paying my bills, which are always paid on time, and everyone thinks that they know more than I do, yet they are not independent for nothing!

  • guest

    Never lend money or borrow money from relatives or friends etc unless you are willing to give it for free. Same for the cosigning or be a guarantor. Generally speaking I usually don’t borrow or lend money,

  • Harry

    All the above 3 items are worthless if the borrower does not honor this agreement loan. Of course the borrower will sign and say they will follow these rules but in the end it is just a gift. So if you want to loan money be prepared to not see it again.

  • mrk222

    I have loaned money to friends and family, under one simple rule, and it has paid off to me by having them accountable, but without pressure.
    1) loan them an amount that they can reasonably repay.
    2) set up a payment arrangement, “I will pay by such a date” “I will pay $X a month”
    3) NEVER loan an amount that you would not be willing to forgive.
    Here is the one rule that I use for the loan under these terms….
    4) Unless and Until the amount borrowed is repaid, gratefully, you make no additional loans and remind they why you “can’t” or won’t.

    A smaller amount repaid shows me that I can loan them greater amounts later. An unpaid amount is proof that I cannot trust them to re-pay and I simply write it off as a gift. Put simply, don’t loan any amount you would not give to a friend or family member as a gift.

    • Credit Experts

      Very good ideas. Thanks for sharing.

  • dollarsmakesense 11

    Also, you should freeze your credit. Not that many people know about credit freezes, but they should.

  • Lucy Farrah DeMonique

    Just tell friends or family that as a lender, you are just an amateur, and therefore unable to do something that even a professional can’t do!

  • hotdang

    Best $100 i ever spent was a loan to a cousin. He never paid it back and he has since asked for loans from other family members but he never asked me again Knowing full well i would ask about the original loan. Once bitten twice shy

  • mark

    a family member is giving me a $13,000 loan…is 20% a fair interest rate?

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