When you loan money to friends or family members in good faith, ensuring repayment can be difficult. Not only does it allow for financial strain, but it can also impact your relationships. No matter how prepared you may be going into the situation, there’s always a possibility for the loan terms to not be abided by.
To prevent unnecessary pressure on your relationship, when you lend money to a friend or a family member, be proactive rather than reactive. Start by writing up a contractual agreement before starting the process and be prepared with alternative repayment options should they not be able to make the payments.
How to best set up your loan with a family member or a friend for repayment
If you find yourself in a situation where you are considering lending money to a friend or family member, make sure that you’re financially healthy. Go through all of the possible scenarios and potential alternatives before dolling out any cash, considering the relational and financial stress that lending a large amount of money could cause.
At the end of the day, you can never be too prepared to minimize the risk of not getting your money back from a loved one.
Be direct
Being direct applies to your communication before you loan the money and how you treat the repayment process. If a family member or friend asks you for a large lump sum of money, have an agreement in writing that details how and when the money will be repaid. While writing an agreement isn’t legally binding like a lender’s loan agreement, it can reduce the risk of not getting your money back.
Sitting down with a family member or friend makes the arrangement more formal and can increase how seriously the borrower handles the repayment process. Most importantly, writing out set loan terms and details ensures everyone involved is on the same page before the money is distributed.
It’s also a good idea to communicate directly during the payback period. This is where having a written document to refer to can be helpful. Try not to be passive-aggressive if a payment is late or missed. If necessary, refer back to your loan terms, be direct with your expectations and set consequences, like interest accrual or fees.
Don’t let too much time pass
Don’t wait too long before mentioning repayment. Otherwise, the borrower may forget to make the payments or misunderstand your timeline. While you don’t want to constantly harass loved ones for repayment, you’ll need to be straightforward about your expectations, like a lender would be. Before lending any money, make sure both parties fully understand — and agree on — when the payments will start.
Be as professional as possible with the process
Mixing money and friends can be a risky endeavor, but to minimize relational risk, try to keep the two separate and treat the process like a business transaction. Consider the potential risk of the person borrowing from you and ask the following questions as part of an application process.
Ask questions as if you were a lender gauging eligibility of a potential customer. Before drafting an agreement or terms, gather the borrower’s credit score and ask them about their financial history and current debt load. You may need to reconsider the loan if you can’t confidently say that you would lend the money if they were a stranger.
You can then suggest alternatives like applying for a credit card, a personal loan from a financial institution or using savings. In this case, backing out before starting can help keep the process as transactional as possible. Just remember to keep your relational experiences out of the picture if that’s what is best for both of you.
Craft a specific payment plan
After gauging the borrower’s financial status and health, craft a repayment plan that works for both parties. The written agreement should cover the following:
- The repayment term (most loans last three to five years, depending on the balance).
- The total loan amount, including the principal and the interest rate, if applicable.
- The interest rate percentage and accrual structure.
- If you’ll charge a late fee and how much it’ll be.
- Whether repayment will be weekly, biweekly or monthly.
- The date in which repayment starts.
- How the borrower will repay you. This can include transferring the money to your account via an app, in cash or through a check.
What to do if you can’t get your loved one to pay back the loan
No matter how strong your relationship is, it’s still a possibility that you won’t get your funds back in your agreed-upon timeline. To eliminate putting more stress on your situation, have a plan in place so you can be prepared for the worst possible scenarios.
Consider alternative payment options
If you’ve expressed concern about missing payments and reviewed your written contract terms with your borrower, then it may be time to brainstorm alternative repayment methods. For example, you can re-write the contract to extend the payment term to make the monthly payments smaller. You can also start accruing interest on the delinquent balance as a motivator.
If your friend or family member has hit hard times and is unable to pay back their balance, consider other forms of repayment in place of money. For example, if you don’t need the cash, maybe they can be your babysitter for a night or two, or they have a skill that you can exchange for an erasure of the debt. While this obviously isn’t the ideal scenario, it can be better than nothing and prevent future relational friction.
Forgive the outstanding debt
If all else fails, you may have to decide between your friendship and the money you lent. If discussing the loan terms and repayment responsibility hasn’t worked and you’re still out of money, it may be best to forgive the debt to save the relationship.
If you don’t need the cash and decide that it may be worth it to forgive the debt altogether, sit your friend or family member down and explain the situation to them in full.
Should you lend your friend or family money?
The decision to lend a large sum of money to a friend or family member isn’t always an easy one. You may be strapped for time, and sometimes there are just as many reasons to say no as there are to say yes. If possible, make sure you have the time you need to make a fully informed decision, but if the situation doesn’t allow for that, have the following details tucked away.
- The reason for the money: What do they need the funds for? You might feel more comfortable lending money to someone if you know why they need it. For example, if they need the funds to cover an unexpected trip to the hospital versus a luxury vacation, that could change the dynamic of the loan.
- Your personal finances: Can you afford to lend them the money they need right now? If you end up lending the money, make sure it won’t impact your ability to cover an emergency or unexpected expenses. Also, make sure that it won’t be too much of a loss if they can’t repay you after all is said and done.
- The repayment timeline: When can they start repayment? Ask your loved one what they can afford and when they’ll start the process. Specify whether it’ll be a short-term or long-term loan based on their ability to repay the balance. While it’s ideal to have the balance repaid in one lump sum, if a longer-term loan is best for the borrower, work together on a specific repayment plan that works for both of you.
- Their borrowing history: Have they borrowed money before? Are their debts current and up-to-date? If they’ve taken out loans or borrowed from you, you’ll have a better gauge of their repayment habits and shortfalls.
The bottom line
Ensuring repayment can be difficult when you loan money to friends or family members. However, there are ways to minimize risk. Agreeing on repayment upfront and drafting up a written loan agreement is key to avoiding miscommunication and ensuring you’ll get repaid in the best way for both parties involved.
If you’re unable to get your money back, consider options that will minimize relational risk, like forgiving the debt or extending the repayment term. To prevent this from happening in the first place, carefully evaluate the borrower’s finances. If you have any hesitation about lending to them, you may want to steer clear to protect your future financial health.
