There’s a reason money lending is one of those businesses generally left to the mob. Loaning cash can be an unscrupulous undertaking. You have to calculate and charge compounding interest rates and in the worst-case scenarios, you have to play collections officer. It’s an uncomfortable position for most people, especially when friends and family are involved.
No one wants to charge his or her best friend interest on a short-term loan. Knocking on grandma’s door to demand repayment of principle is an even less appealing activity. So how does one navigate the minefield of personal lending?
One way to handle it is to refuse to get involved. There’s a reason your friend or brother-in-law is coming to you for quick cash. If he or she is too unreliable to qualify for a commercial loan, chances are he or she will be a huge headache as a debtor. It isn’t always easy to say no, however. These are your closest relationships, after all. You probably do want to help them. You can be both friend and creditor, but it’s a fine line to walk. These five rules for loaning money to friends and family can help you navigate these choppy waters.
1) Write out the terms of the loan
A common theme among these rules is professionalism. A financial loan is a business arrangement. As such, you want to make it appear as official as possible. If you put the terms of the loan in a contract or quasi-contract then you increase the likelihood that your debtor will make his repayments on time. Clearly, you don’t want to initiate a breach of contract lawsuit against your sister. That’s not the point of the writing. The contract is there as a reference. It’s a way to remind your debtor that the two of you agreed on the terms of the loan beforehand.
2) Charge interest
You may feel compelled to grant your relatives a zero-interest rate, but this is not the best way to handle a personal loan. Money now is worth more than money later. If you make a zero-interest loan you’re actually losing money. Find a fair interest rate and include it in the writing.
3) Have a discussion with a witness
If you’re lending money to a friend, you have a responsibility to make sure that the money goes somewhere productive. If your debtor has a history of addiction or gambling, you don’t want to be an enabler. Set up a frank discussion with a third party present to establish some ground rules for how the loan money is spent. You don’t need a band decision weighing on your conscience.
4) Create a repayment schedule
This one should be obvious: create a repayment plan and put it on the books. If your debtor has a schedule that he or she can refer back to, he or she is far more likely to stick to the plan. As long as your debtor continues to make timely payments, you don’t have to serve as a collections officer.
5) Recommend other sources of cash
If your friend can’t comply with these rules, direct him or her towards other sources of quick cash. Just because someone doesn’t qualify for a commercial bank loan doesn’t mean he or she can’t find cheap money elsewhere. Companies like payday loans Florida regularly make loans to persons who don’t qualify for bank loans.