Updated on 10 June 2015.
It's a situation that most of us face at some point; having a friend or family member ask to borrow money.
However, although you may have the best intentions and want to help them, you may find yourself in a quandary and rightly so; difficult as it may seem you need to put your financial wellbeing first.
So if you're faced with a friend or family member asking for money here's what should you consider before writing a cheque:
Lending money to a friend or family member can often seem like a good way to help out - especially if it helps them to avoid paying high interest charges to the banks.
Yet, if they can't afford the loan, you could end up losing more than just your money.
So, if you are asked for a loan by a friend or family member, you should seriously consider the following before making a decision:
Before you even discuss the possibility of lending money you should decide whether you can afford to part with the cash.
This is not simply a case of whether you have the funds in the bank, if you loan the money to a friend or family member there is a good chance you won't get it back for months to come.
You'll need to ask yourself how you would deal with an unexpected expense. Would you be able to cover it with the money you have left or would you be forced to borrow yourself?
Additionally if you are working towards a financial goal such as clearing your debts, or saving for a house you should consider how it far it will set you back.
You'll also need to consider whether the friend will be able to repay you, and if you trust them enough to do this without having to chase them for the money.
Consider if they are working, how much they are earning and what other financial commitments they are already tied too.
If they don't have much money coming in and are already struggling to pay their bills will a loan really help them further, or will you simply lose your money and your friend as they are unable to pay? It may also be worth looking at how effectively they have managed their money in the past, if others have lent them money and struggled to get it back you may want to be more cautious.
The reason your friend needs the money is also likely to influence your decision.
If they need it to pay for car repairs or a replacement boiler you may feel more inclined to lend the cash than if they simply want to book a cruise around the Mediterranean.
Some people may be reluctant to tell you why they need to borrow, but as it's your money at stake you are well within your rights to ask what it will be used for.
If you are concerned that they are hiding the real reason they need the money you should avoid lending them the cash, or ask if you can pay the money directly where it's needed.
Perhaps one of the trickiest parts of lending money to a friend is deciding whether to charge interest and if so how much.
It's important to remember at this point that if you are taking your money out of your savings, or reducing the amount you're paying off debt you're likely to lose money by lending to your friend.
Although it can seem harsh, especially if your friend genuinely needs the cash for an emergency, if you don't charge them any interest you will essentially be paying for the privilege of lending your own money!
While charging interest to a friend may seem a little mercenary, there is nothing wrong with doing this. Consider asking for an amount equivalent to that which you would have earned if the money remained in your savings account.
While not necessary in most cases, if you are wary of lending to a friend because of their financial background you may want to consider asking for some form of collateral.
This is where the person who is lending you money gives you something of value to hold against the value of the loan until it has been repaid.
Anything can be treated as collateral but it is usually something of sufficient value to cover the amount of money you have lent out.
If you decide to lend the money there are a number of ways you can protect yourself just in case your friend renegades on the agreement:
1. Set the terms
Before you lend the money make sure you agree exactly how much you'll lend, at what rate, over what term & how much they'll be expected to repay each month.
If you've decided to ask for collateral, you will need to agree what you will hold and when you would be free to sell the item or items to get your money back should they fail to stick to the repayment terms.
It's essential that you are both aware of all of these conditions before any money is exchanged.
2. Write a contract
Drawing up a written agreement or contract which lists all the agreed terms of the loan not only makes it clear to you and your friend what you are agreeing to, but also provides you with a record of the agreement should there be any dispute.
You and your friend should both sign it in the presence of independent witnesses.
If it's for a significant amount it may be worth getting a solicitor to help you do this or ask at the Citizen's Advice Bureau to see if this is something they can help with.
3. Transfer the money
Once you and your friend have agreed terms and signed a written agreement you are free to transfer the money.
Preferably you should transfer the money by cheque or bank transfer; this will ensure that there is a record of the payment that can be easily confirmed in future.
If you have decided to clear a debt or bill directly on their behalf then make sure that you get some form of confirmation of payment.
4. Set up repayments
After transferring the loan you will need to ask your friend to set up a standing order to your bank account for the agreed amount and get confirmation from the bank or building society that this has been done.
5. Record repayments
Now that the loan is active, you will need to monitor the repayments and keep a record of when you have been paid.
Doing this will ensure that there are no disagreements as to when the loan has been repaid or what is still left to be paid.
6. Keep your agreement up to date
If you need to change your agreement make sure you revise your contract accordingly, and again get you and your friend to sign it in front of witnesses.
This way if your friend needs more time to repay then you can keep track of exactly what has been agreed.
If your loan agreement with a friend breaks down, your actions will largely be dependent upon your reading of the situation.
If your friend is struggling to meet the repayments as agreed you should encourage them to speak to you about the problem. Try to agree with them the best course of action to repay their debts.
It may be that you have to extend the term of the loan so they can spread out their repayments or possibly offer them a 'payment holiday' if their problems are only temporary.
However, if things go badly wrong and you need to get your money back you may need to go through the legal system.
If the loan was for less than £5000 you may be able to make a claim for the money via the small claims court.
If the loan was for more than £5000 then you'll need to seek independent legal advice, to find out how to try and get your money back.
If you decide that lending to your friend is simply too risky or that you can't afford it then there may be a number of different ways that they could raise the funds.
A Budgeting loan from the Social Fund may be one option, this is an interest free loan for people who are already receiving certain benefits.
Alternatively, if they are trying to pay a bill they weren't expecting then they can read our guide on using an emergency fund for more options.
Written by Martin at money.co.uk
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