Has it ever occurred that someone close to you asked you for a loan? In such cases, one tends to feel a lot of things, you want to help your loved one, you worry about whether or not you will be paid back, you wonder why they need a loan in the first place, and if you even have that kind of money to lend. There are chances that you also have questions concerning that law when it comes to loans. How to lend money to a friend?
According to some studies conducted by the Federal Reserve Board Survey of Consumer Finances, every year, in the United States alone, the loans from family and friends can sum up to a heavy total of $89 billion. The most common reasons to ask for loans from friends or family members is when someone wants to start a business or buy a house. Fundable conducted a national survey and the results showed that 38% of startup businesses were founded by money lent from family or friends. Moreover, The National Association of Realtors conducted a survey and showed that 6% of people who had bought a home for the first time had borrowed money from family, mostly parents, to buy it.
Furthermore, when a family member or friend suddenly gets unemployed, or gets struck by a sudden illness, that is also a time when most people seek loans from loved ones. Other than that, people also borrow money for reasons like buying a car, a computer or other technical equipment. It can also be for something a little more personal such as getting an engagement ring or paying for a family holiday. So, what does the law say about loaning money to friends and relatives?
Table of Contents
- 1 Lending Money To Friends And Family
- 2 Personal Loan Agreement Between Friends
- 3 Simple Loan Agreement Sample
- 4 Tax Implications Of Loaning Money To A Friend
- 5 Preserving Your Personal Relationship
- 6 Conclusion
Lending Money To Friends And Family
The moneylender has the most to lose, both literally and allegorically, in circumstances where there is a credit concurrence with family or companions. The moneylender not just puts his cash at risk but also places his notoriety and relationship at serious risk, as well. He could lose everything – cash, family and kinships – if things turn out badly and he stands to get slightly more than a couple of dollars of interest if everything goes right. Therefore, it is extremely important for individuals to spend some time in thought and to consider making a loan offer to someone before crediting cash to family or companions. It may very well be a costly experience.
If you decide to lend money, then remember that there are certain things that you have to keep in mind when lending money to friends. A few of them are mentioned below.
Only Say Yes If You Mean It
Do not let yourself be guilt tripped into paying the loan or agree to paying it if you do not have the money. Refusing to lend money does not make you a bad friend, in fact it helps secure bonds and protect them further instead of crippling the relationship even before the loan is made.
Lend Only The Amount That You Can Afford To Lose
Regardless of whether the person you are loaning the money to is an immediate family member or your best friend, lend only the amount that would not put your financial position at risk if it is not returned. Your friend may be the most trustworthy and reliable person you know, but you have to remember that anything can happen which is why it is important that you only lend the amount that you can afford to lose. This will not jeopardise your relationships or your savings and future plans.
Create A Strong Repayment Timeline
Make sure that you have a well thought out repayment plan that would help both you and the person you will lend the money to, to be on the same page. Moreover experts believe that since loaning money can involve complicated tax rules, you should make the repayment plan in such a way that it involves charging an interest otherwise, it can get you into trouble.
Have The Loan In A Written Form
It is always advised that both parties sign a contract or have the loan written down somewhere. Moreover, having an official document for the loan makes the borrower treat it seriously as well and chances are that the loan will be paid on time.
Do Not Let The Due Date Slide
Your loan agreement should seem like a business deal so that neither of you ends up taking advantage of the other. Ignoring late repayment would be a mistake on the lender’s part. If you let it slide once, the borrower can continue to make a habit of it. However, usually a 5 to 7 day grace period is allowed.
Collateral Or Security
Most of the time, people who lend a loan, often obtain a collateral which the lender can then sell in case the loan is not repaid on time. A collateral is of the same value as the loan, however, sometimes, if the borrower cannot give a collateral, they give something of theirs that holds a sentimental value. This allows the parties to stick to the terms discussed.
Take Action If They Fail To Repay
If the borrower fails to repay the loan, then try to first resolve the matter yourself. At this point, you can alter the terms and conditions, given that both parties mutually agree to it. If the agreement is violated and you still want your money back, you can then take legal action.
Personal Loan Agreement Between Friends
As we have already established, it is always a good idea to sign a loan contract or agreement regardless of whether you are lending money to a loved one or to someone else. There are various different loan loan agreement samples that you can find on the web. The basic format includes mentioning the names and the amount that is being loaned. Following are the basic aspects that are mentioned in a personal loan agreement between friends:
- Date when the loan agreement is made
- Name and address of the borrower
- Name and address of the lender
- Terms and conditions that state when the borrower will repay the money and the amount of money he/she owes
- A statement of liability which mentions that both individuals are responsible for paying back the full payment on time.
- The details of the loan agreed upon by both the parties which includes: the amount of loan; the amount financed; finance charge; any other applicable charges; the total of all of the payments; and the annual percentage rate.
- A detailed statement of repayment which mentions the amount, the date when it was issued and the date of repayment.
- Signatures of both the parties.
Simple Loan Agreement Sample
A simple loan agreement sample follows the same pattern as a personal loan agreement between friends. However, there are certain additions as mentioned below.
- Details of both the parties involved which includes the full name and address of the borrower and the full name and address of the lender.
- The date of agreement.
- The time period for which the loan will last e.g. three months.
- The amount of the loan.
- The amount of interest.
- Any agreements concerning prepayments. This includes agreements on whether or not the amount will be paid in installments.
- Terms and conditions regarding late charges.
- Terms and conditions regarding collection fees.
- Terms and conditions regarding insolvency.
- Terms and conditions regarding severance.
- Terms and conditions regarding dispute resolution.
- The currency in which the loan is borrowed.
- Details concerning the payment methods such as: the lender’s account name; the lender’s financial institution/bank name; the lender’s BSB number; and the lender’s account number.
- A statement of confirmation.
- The date of execution of the agreement.
- The signatures of both the parties involved.
Tax Implications Of Loaning Money To A Friend
If in any case, you give somebody a loan without charging an interest, you will be liable to below-market premium guidelines. According to the IRS laws, you have to calculate and ascertain imaginary payments with an interest from the borrower. This nonexistent interest amount is then payable to you. Therefore, when you will be filing a tax return, you would then have to pay taxes on these interest payments. To muddle matters further, if the imaginary interest amounts surpass $15,000 for the year, there might be an adverse gift and you would have to deal with estate tax consequences.
As was referenced above, in case that you do not charge any interest, or interest that is beneath the market rate, the IRS can easily think that your loan was probably a gift. This is particularly the case if there is no proper documentation (i.e., composed concurrence with installment timetable). If the borrower defaults on the loan, or the IRS chooses to review your case and concludes that your loan was a gift, then you can go through a really bad debt deduction.
Usually, a formal document for a loan involves a written promissory note that mentions the interest rate; a repayment plan that has the dates and amounts for all principal loans along with the interest; and security or collateral for the loan, such as a residence. It is important to ensure that the document has the signatures of both the parties so that it is legally valuable and binding.
While giving a loan, you have to make sure that you charge an interest amount that is equivalent to the applicable federal rate (AFR) endorsed by the Internal Revenue Service, you can maintain a strategic distance from charge entanglements and ominous tax outcomes.
Preserving Your Personal Relationship
If such a situation arises where you or your loved one could not repay the loan on time, it is extremely important that you keep the doors of communication open. A good communication between the borrower and the lender is the key to prevent animosity within family or friends who have loaned you money. Whether you like to believe it or not, any person who lends money feels like it is an investment. They would definitely want to know how the project or business is doing for which they loaned you that amount and when the loan would be paid off.
This is the reason why having everything regarding the loan is so important to be written down on paper. At the end of the day, we are all humans and not machines, so it obviously becomes difficult to remember everything in detail. However, if you have documentation concerning the loann it is easier to reach a verbal understanding with family and friends. Therefore, write everything down and make sure both parties are aware of and understand the details of the loan agreement.
Moreover, out of courtesy’s sake and also to maintain a proper record of things, the borrower should consider providing the lenders with monthly, quarterly or annual updates to discuss the project or business for which the loan was acquired. This helps identify the issues that may arise in paying off the loan (if there are any) and also aids the parties involved to figure out any alternative relief options while the problem is being resolved.
Lastly, both parties should keep in mind that it would not be a smooth sailing ride. There will be ups and downs, so they need to decide ahead of time how they are going to deal with those situations. It is totally natural for emotions to run high when it seems that you are losing money. However, one also needs to remember that getting into a heated quarrel over unpaid loans, with friends or family, is not going to get you anywhere.
Both sides should keep their expectations realistic. The borrower should make repaying the loan a top priority and the lender should expect some troubles. After all, financial instability is usually the reason why someone asks for a loan in the first place.
If you are planning to lend money to a friend or a family member, You need to first give it a good thought and ask yourself whether or not the loan is a good one to make. If the borrower cannot repay the loan via traditional means, then it is probably not worth the risk for you. However, if you still go ahead and lend the money, then make sure that you also have it as a written document otherwise known as a loan agreement. The loan agreement should comply with all of your state’s laws. Despite all of this, it is still better if you consider all of the consequences of lending money before you actually do it since it takes very few things to ruin a relationship faster than money issues.