Lending money to friends and family can be a difficult situation to be in. Needless to say, lending of this nature involves emotion, commitment, and trust. It’s difficult to say no especially when help is needed and you are capable of providing financial support. Deciding whether to help a friend or family member can be tricky, and for a lot of people, money is a taboo topic which means that there are things that should be discussed but often aren’t.
Is lending to friends or family a good idea?
Lending money to a friend or family member can often seem like a good way to help out especially if it helps them to avoid paying high interest charges to a bank. However, although you may want to help them, you need to put your financial wellbeing first. If things went wrong, you could end up losing more than just your money. For example, if you take money out of your savings or reduce the amount you are paying off your mortgage, you would technically lose money by lending. Although it can seem harsh, if you do not charge them any interest you will essentially be paying for the privilege of lending your own money. It may be worth considering asking for an amount in interest equivalent to that which you would have earned if the money remained in your savings account.
So, if you are asked for a loan by a friend or family member, you should seriously consider the following questions before making a decision:
Q: Can you afford it?
Decide whether you can afford to part with the cash, its not simply a case of whether you have the funds in the bank as you will not get the money back for months to come. Ask yourself how you would deal with an unexpected expense. Would you be able to cover it with the money you have left or would you be forced to borrow yourself?
Q: Can they afford it?
Why do they need it? If they need money to pay for car repairs or a replacement boiler, you may feel more inclined to lend than if they want to holiday in the Bahamas. If you know your friend or family member, it’s highly likely that you know the person’s lifestyle. You know whether the person is thrifty, extravagant, or anything in-between. If you see that the extravagance results in asking for a loan, then, it is in your best interest to not lend your money. You don’t want to be in a situation where you are sustaining their unsustainable lifestyle. If they are reluctant to say why they need to borrow, remember it is your money and you are well within your rights to ask what it will be used for. Decide whether the person will be able to repay you and if you trust them enough to do this without having to chase them for the money.
You should also consider if they are working, how much they earn, what other financial commitments they have and how effectively they have managed their money in the past. If they do not have much money coming in and are already struggling to pay their bills, another loan might not be what they need. If others have lent them money and struggled to get it back, you may want to be more cautious. You could end up losing your money and your friend if they are unable to pay.
Protect yourself – Documentation is key
If you decide to lend the money, there are a number of ways you can protect yourself:
Set the terms
Before you lend the money make sure you agree exactly how much you will lend, the interest rate (if any), the length of time they have to repay you and how much they will be expected to repay each month. It is essential that you are both aware of all of these conditions before any money is exchanged.
Write a written agreement/contract
Drawing up a written agreement or contract which lists all the agreed terms of the loan makes it clear what you are agreeing to, and also provides you with a record of the agreement should there be any dispute. You and the borrower should both sign it in the presence of independent witnesses.
By putting the terms of the loan in a written agreement, this sends the message that this is not a gift; it is a loan which they are liable to repay. If it is for a significant amount it may be worth getting a solicitor to help you do this.
Transfer the money
Once you and your friend have agreed terms and signed a written agreement, you are free to transfer the money. Preferably you should transfer the money by bank transfer or even cheque; this will ensure that there is a record of the payment that can be easily confirmed in future. If a bank transfer is the method of choice, it would also be worth marking the transfer with the payment reference of “loan” in the event that there is ever a dispute as to the terms of the money changing hands.
If you decide to clear a debt or bill directly on their behalf, make sure that you get some form of confirmation of payment from them.
Set up repayments
After transferring the loan, you will need to ask your friend to set up a standing order to your bank account for the agreed amount and get confirmation from the bank or building society that this has been done.
Once the loan is active, you will need to monitor the repayments and keep a record of when you have been paid. Doing this will ensure that there are no disagreements as to when the loan has been repaid or what is still left to be paid.
Keep your agreement up to date
If you need to change your agreement, make sure you revise your contract to reflect this. Both of you should again sign it in front of witnesses.
That way, if your friend needs more time to repay, you can keep track of exactly what has been agreed.
Avoid micromanaging the borrower just because you loaned him/her some money. Divorce yourself from doing that and focus more on getting repaid. Your job is not a micromanager but a lender. If you do micromanage the borrower, there is a possibility for harboring negative feelings such as conflict and disagreement.
Should you obtain collateral?
While not necessary in most cases, if you are wary of lending to a friend because of their financial background, you may want to consider asking for some form of collateral. This is where the person who is lending you money gives you something of value to hold against the value of the loan until it has been repaid.
Anything can be treated as collateral, but it is usually something of sufficient value to cover the amount of money you have lent out.
You will need to agree what you will hold and when you would be free to sell the item to get your money back should they fail to stick to the repayment terms.
What if things go wrong?
This would be one of the worst-case scenarios but it happens often. The borrowers (i.e. your friends and family) are more likely to not pay off the loan because they would expect you to be a bit more lenient. After all, they know you well. Make sure that when you loan money to your loved ones, you prepare yourself for the possibility of not seeing that money anymore.
If your friend struggles to meet the repayments as agreed, encourage them to speak to you about the problem. Try to agree with them the best course of action to repay their debts. It may be that you have to extend the term of the loan so they can spread out their repayments, or possibly offer them a ‘payment holiday’ if their problems are only temporary. However, if they refuse to repay and you need to get your money back, you may need to go through the legal system.
If the loan is for less than £10,000, you may be able to make a claim for the money via the small claims court. Consideration also needs to be given to the fact that you run the risk of destroying relationships.
Lending your hard-earned money to your loved ones is a challenge. However, before you let people borrow money from you, make sure that you have considered all the factors and know what you are getting into. This way, in the end, you won’t regret what you did or didn’t do in this kind of lending situation.
To discuss any of the information raised in this article, please contact Portia Woodhouse, a Chartered Legal Executive in our Dispute Resolution Department in Newton Abbot, by telephone on 01626 202395 or by email PortiaWoodhouse@wbw.co.uk. WBW Solicitors has offices in Newton Abbot, Exeter, Torquay, Paignton, Bovey Tracey, Launceston, Honiton, Exmouth and Sidmouth.
This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.