In 2011, 60-year-old Neeraj Patel (name changed) lent around Rs 20 lakh to a close friend who was in financial trouble and needed money to start his own business. His friend had a good reputation, so Patel didn’t hesitate to loan out his life’s savings without any formal paperwork. However, in the years that followed, Patel’s friend refunded him the equivalent monthly installment (EMI) twice for two consecutive months, but quit after that. Things got worse when Patel’s friend died a few years later.
Almost a year later, after recovering from the shock of losing a dear friend, when Patel and his family approached his friend’s son, who worked for a reputable multinational, for the money, they received no response. Patel soon realized that this savings had turned into a bad loan.
“The son initially agreed to meet me, but he didn’t show up for the meeting. After that, he even stopped taking my calls,” Patel laments.
You are clearly a “good Samaritan” when you lend money to your friends or family in times of need. But your “goodwill gesture” will be wasted if your efforts result in misunderstanding or financial loss.
Here are five do’s and don’ts when lending money to friends or family:
Ask yourself if you can afford it
You should first think about your own financial situation when a friend or family member asks you for money. If lending someone money is putting a strain on your finances or if you have to make a lot of sacrifices to manage your expenses later on, you should avoid doing so. However, if you have enough savings or a big enough emergency fund, and little or no debt, you might be able to help out a friend.
Charge interest and use collateral
“Money can be thicker than blood, and it can ruin relationships. So for the sake of the relationship, it’s best to keep things on point from the start. We have to keep our emotions in check because friends and family can take things casually. To avoid this, it is better to have a fixed interest rate and collateral security on the loan amount,” says Hemant Beniwal, Director of Ark Primary Advisors, a financial planning company.
Have a written agreement
This is a difficult, even awkward, thing to do, but a written agreement will help avoid any misunderstandings and clarify the responsibilities of both parties. The agreement gives you grounds for legal recourse in the unfortunate event that you need to sue them later to get your money back.
Don’t be guided by emotions
If you think your friend or family is really in need, you can lend them some money. But also consider the repayment capacity of the borrower. If they work, find out how much they earn and what their other financial commitments are. Also try to find out if the borrower is responsible for the finances.
“Often people lend based on their emotions and don’t actually treat those loans as serious unpaid debt. They tend to take these loans casually because there is no interest to pay and they are unlikely to lead to legal complications,” says Beniwal.
Don’t feel obligated when it comes to money
Ideally, you shouldn’t lend money just out of obligation. If the loan doesn’t make sense for you financially, don’t go ahead. Also, when we are aware of a person’s liabilities or know that they have a bad credit history, we must accept that the borrower will most likely be unable to repay. In this case, it is better to avoid lending at all. “Also, as a lender, you have the right to know what the money will be used for. If the reason seems illogical to you or if you think the person is taking the loan simply to satisfy their aspirations for luxury, you should avoid such deals,” Beniwal adds.
Although the decision to grant the loan is entirely up to you, following the do’s and don’ts mentioned above will protect your money and your relationship with the friend or family member, which can be very valuable.