The Dos and Don’ts Of Lending Money To Friends Or Family
Almost everyone finds themselves in circumstances when they have to lend money to family or friends. You feel pressured to lend a hand when someone close to you needs money, as the situation involves emotion. In such situations, many promises are made regarding the timing and the method of loan repayment.
However, the key issue here is that when you lend money to relatives or friends, you frequently experience payback delays or never receive your money back. Many problems may arise in this scenario. In this post, we’ll provide you with some advice on how to handle loan lending to relatives and friends.
When Do Loans For Friends and Family Make Sense?
A friend or relative may ask you for a loan in some specific circumstances. For instance, they may ask you for a loan if they:
- Need cash right away to pay for an urgent expense.
- Lack the credit history needed to be approved for a line of credit or personal loan from a financial institution.
- A job loss or sickness prevents them from earning enough money to qualify for a typical loan.
It’s usually not a good idea to lend money to someone; doing so can strain your finances and make it difficult for you to manage yo ur own expenses. Loan lending, however, would not be as challenging to handle if you have a large emergency fund, little to no debt, and a consistent source of income.
Being paid back will not be a problem if the friend or relative requesting the loan is generally responsible with their bill payments and has been only going through a brief financial difficulty.
On the other hand, if a person has a track record of poor money management, you are incurring a higher risk by lending them money.
Only Lend Money to Somebody You Can Trust
Being selective about who you lend money to is vital if you lend money and hope to get it back. In addition, you can avoid future financial and emotional stress by giving loans only to family and close friends whom you can trust with repaying your loan.
It’s okay to say that you are not comfortable with lending money. Offering money is important if you are sure that it won’t damage the relationship.
Document Your Agreement
Having a paper trail when you lend money to friends or relatives can prevent any misunderstanding between the lender and the borrower. When you and the borrower agree on and sign a loan contract, it will make your duties clear along with giving your agreement a written proof. It provides you with legal grounds for action if you need to sue the borrower later to get your money back.
Your loan agreement must at least contain the following:
- Names of you and the borrower
- When the loan was approved
- The sum of money lent
- The smallest monthly payment
- The due date for each payment
- The interest rate if you choose to charge interest
- Consequences of not repaying the loan
It is a good idea to hire a lawyer to prepare a contract for you if the loan is for a higher sum. If you intend to charge interest on the loan, consulting a tax expert is advisable.
Limit Your Loans
If it strains your resources, lending a massive loan, even to close people, is not desirable. Consider the loaned money as a gift while determining the amount to be lent to the borrower. Think about it this way: how much money can you lose without negatively impacting your finances?
This does not imply that you believe you won’t get the money back. Instead, this way of thinking helps you establish sensible limits on the lent money to friends and family.
Avoid Letting Guilt Influence Your Judgement.
You must resist the urge to lend money to someone you know out of guilt or a sense of being obligated. However, if you feel compelled to lend money to someone and doing so can strain your finances, it’s advisable to take some time to think of other ways to support them. You can lead them towards alternative means to procure money for their needs.
Never Lend More Than What You Can Afford.
Even though it should go without saying, we’ll repeat it. Lending more money than you can reasonably afford will only push you into trouble if the borrower defaults on the loan or if you find it more challenging to meet your own financial obligations after becoming the money lender for them.
Avoid Lending Someone Your Credit.
Instead of providing them money yourself, you may make an offer to co-sign a personal loan for them, or allow them to use your credit card in an emergency. In such a situation, you would not have to pay anything out of your pocket.
However, the payment history, and the loan balance that will appear on your credit report as a result of co-signing such a loan can impact your credit score significantly.
And if someone else makes purchases with your credit card, you are solely liable for debts they incur. So you should consider this alternative to lending loan only as a last resort.
Is Money Lent to Family Tax Deductible?
For income tax purposes, much like in the normal cases, the lender is subject to taxation for intra family loans as well. This interest amount earned from intra-family loans are taxable at ordinary tax rates as applicable. Additionally, if the lender accepts a below-market interest rate or forgoes a part of the loan amount.
this could be seen as a gift to the borrower and is subject to the gift tax.
Why It’s Not a Great Idea to Lend Money to Friends or Family?
If you lend someone money and they have difficulties repaying it.
Your friendship and family relationships are likely to suffer in the process. Often, the psychological harm feels worse than the financial loss. It’s a good idea to keep family and finances separate.
if you feel forced to lend them a loan, be aware that there is a possibility of not getting your money back.
Obtaining a traditional loan can be difficult for those with a low credit score or a bad credit history. If that’s the sole reason they’re asking you for money, direct them to a flexible lending platform like LenDenClub, which is a P2P lending platform.
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