How to Lend Money

Never lend money is a warning commonly offered by financial experts. Not opening your wallet may be the safest approach, but the truth is, many of us at one time or another want to help out a friend or family member in need. If you decide to become a lender, here is how you can do it wisely:

  • Don’t lend money you can’t afford to lose: Even if the borrower is 100% dedicated to repaying the loan, stuff happens. Perhaps he or she suffers a job loss or has to pay for an expensive unexpected car repair. You always have to be prepared for the possibility that you won’t receive your money back. If you lend cash that you need to pay the mortgage or other essential expenses, not only are you putting yourself in a precarious financial situation, but you will probably become more frustrated with the borrower if you do not get you money on time, possibly damaging your relationship.
  • Get the agreement in writing: Do you remember the exact details of all of the conversations you had yesterday? Last week? Last month? Last year? If you only agree on the terms verbally, it is possible that both you and the borrower will genuinely remember them differently. (The borrower may even think you intended the money to be a gift!) By writing down the repayment terms, including the amount borrowed, interest rate, and payment schedule, there will be no question as to what was agreed to. (It will also come in handy if you need to go to court to collect.) Make sure each of you has a copy signed by both of you. You may even want to have them notarized.
  • Be aware of the tax implications: The interest that you earn on a loan is considered taxable income. If you do not charge any interest and the loan amount exceeds $10,000, there may still be tax consequences. The IRS requires loans to come with a minimum interest rate (called the Applicable Federal Rate), and the interest can be considered income even if you don’t actually collect it. It is a good idea to consult with a qualified tax advisor about your tax liability if you are lending this much.
  • Give a reminder: Even though the loan agreement should contain the payment schedule, the borrower probably won’t put it in a visible spot. So that he or she does not forget about the payment, give a friendly reminder before the due date. Sending an e-mail is one option. Or you could give the borrower a loan coupon book.
  • Communicate and cooperate: If your friendly reminder fails to work, instead of stewing silently or angrily demanding the money, try to communicate with the borrower calmly. If he or she is experiencing ongoing difficulties, can you work out an alternative repayment agreement (for example, accept $100 a month instead of $150)? You would probably prefer to get paid back more slowly than to have the borrower stop paying completely because the payments are not affordable. You can go to small claims court to collect, but it can be time-consuming (not to mention kill the relationship), and it is usually best used when all else fails.