If a friend or family member has ever asked you for money you know how awkward it is. Your money is something that you worked hard to get and your relationship with that person is important and valuable to you. You don’t want to lose your money or hurt your relationship with that person so the idea of a loan doesn’t sit well with you but helping somebody often takes precedence over sound reasoning.
If you’re going to make the loan, make it in a way that minimizes any damage to your relationship with that person. Here’s how.
Write it Down
Asking your friend to sign a contract may seem a little bit heartless but you can always come up with a more palatable reason. You need it in writing for your taxes, your spouse would feel better about it, or be honest and say that you’ve seen friendships ruined over verbal agreements and that person is too valuable to you to lose.
Of course working with an attorney is the most thorough option but that seems a bit overkill if the loan isn’t for a substantial sum. Instead, look at sites like lawdepot.com that offer standard loan documents that you can customize to fit your needs. Still too formal? Write something out that provides the loan amount, the interest rate and the payment details. In small claims court, that will be enough.
Get Some Collateral
Once again, it may seem a little too shady bankerish to you but remember that your money is often not yours alone. It’s your family’s money and you have more of a responsibility to them than you do to your friend. Ask your friend for collateral that is worth more than the loan. Then, go to an attorney and legally perfect the collateral. This puts the property in escrow and allows you to claim it if the person defaults.
This is appropriate for larger loans since attorney fees would make in impractical for a few hundred dollars.
Now you want to make money on the loan? What kind of friend are you? First, if you loan somebody money and it were 100% paid back to you, you still lost money while it was out of your possession so they should pay you for that. You could invest that money and make a conservative 4% each year so why shouldn’t they pay you interest?
In order to avoid gift tax issues, the IRS requires you to charge a minimum amount of interest on personal loans. Unless you’re charging a large interest rate, you’re not making money. You’re just not losing any.
Don’t Do it!
Does all of this sound a little heartless and the act of an uncaring and untrusting friend? Good! Don’t make the loan. Making loans to friends and family often doesn’t end well. If you don’t get the money back, the relationship is severely strained, you look like the mean debt collector, and in the end, everybody loses.
If you want to help, give them the money as a gift without any expectation to pay it back. Tell them that if they want to do something in return, put that money in to a college fund for their children once finances improve.