5 Rules for Lending Money to Friends

Businessman hand sending money to another business person.
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We’ve all been there. A good friend ends up in a financial pickle and our first instinct is to come to the rescue. Great idea, right? Well, maybe.

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“Friendships can very easily be ruined by conflict over financial help,” said Elise Nussbaum, CFP, financial coach at Neighborhood Trust Financial Partners.

First, you might want to figure out whether there are other ways to help the friend. It could be that your friend has landed in a sticky situation and is panicking — you can help the friend understand exactly what’s happening and how to take action.

“Remember that there are many different ways of being a friend,” Nussbaum said. “If you can’t provide serious financial support, you can still be there to listen to what they are going through, share your own perspective and brainstorm ways they might be able to get through the present situation.”

Ways to do this include helping the friend get a personal loan, financial counseling or even moving around credit card balances. However, even here you want to be careful.

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“Co-signing on a loan might not feel like as big a deal as loaning money directly; but, as a co-signer on a loan, you are legally as responsible for that debt as the borrower,” Nussbaum said. “The debt will be reported on your own credit report; and, if they stop paying due to financial hardship, you might not even know about it until your credit score takes a dive.”

If you do decide to lend the money, there are a handful of recommendations to follow. Also see what experts say about lending money to family.

Lend Only What You Can

This should seem obvious, but in the heat of the moment, it might not be. We all want to help our friends, but the question here is: Can you afford it? If you sit down and crunch your personal budgeting numbers and find that it’s not feasible, then don’t do it.

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Get It in Writing

“You potentially won’t have any legal recourse to collect on just a handshake,” said James Holbach of Steelyard Invest.

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If you do decide you have the money to give, you should consider a contract that clearly lays out how much is being lent and how it is expected to be paid back and when. You might even want to consult a lawyer to get the terminology right; but, according to a 2011 study in the Journal of Consumer Research, just signing something predictably influences subsequent behavior. 

To Collect Interest or Not? 

This is something to consider, Holbach said.

“If you are [collecting interest], you could run afoul of state laws regulating lending,” he said. “Also, that’s income, so depending on the sums involved, you could be creating a tax situation for yourself.”

Make sure you understand the laws in your state so everything is above board. 

Communication Is Key

Once your contract is signed and you have lent the money, stay in communication about it. Things can change for both of you, but neither of you will know that if there’s not an open dialogue.

Maybe you need to alter the contract if the friend is having a hard time paying back the money, or maybe the friend got a windfall and can get you the cash sooner than expected.

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As long as you’re talking about it openly and honestly, it’ll make the whole process easier. 

Expect To Not Be Repaid 

This is circling back to the first point: If you don’t have it to give, you don’t have it to lose.

“Someone in financial distress has a high chance of not being able to repay a loan,” Holbach said. “So you should be very cautious not to lend money you can’t afford to lose.”

Nussbaum concurred: “A good rule of thumb is to lend your friend only as much money as you can afford to give them. In fact, your friendship will probably weather the storm better if you think of it as a gift. That way, you can let go of any weird tension that might arise around their ability to pay you back right away.”

Even with the closest friends, there might be circumstances in which you are not repaid, and you have to be OK with that. If you are not, do not lend the money. 

Of course, you might decide this isn’t something you can or want to help out with, and that is more than OK. You can communicate to your friend that you’re unable to help out financially but can assist in other ways.

As with all things in life, using your best judgment is the way to go. As Holbach said, “Common sense, common sense, common sense.”

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