If a friend or family member asks to borrow money from you it can be tempting to help them out, but if things go wrong it can not only put your relationship in jeopardy, you could also end up in financial trouble yourself.
There are a few things to consider before you lend money to a friend or family member.
If you do lend them money, will it cause problems with your friendship? Will it make it hard to see them if they don’t pay you back, and what would you do if they’re not able to repay the loan?
No matter what the reason for them coming to you, it’s important to carefully look at all of your options to make sure you’re doing the right thing.
For example, they may want to borrow money from you to pay off a high-interest loan or to tide them over between jobs.
But you have to put your financial well-being first. If things went wrong, you could end up losing your money and your friendship.
The first thing to ask yourself is if you can afford the money. It shouldn't be money that you rely on, or money you need for yourself – to pay household bills or childcare costs, for example.
Then you need to think of the potential scenarios that might occur. What if your friend then loses their job and takes longer to repay you, maybe they take out another loan that they decide to pay off first. Would you be comfortable if your friend didn’t pay you back on time and it took them a little longer?
While some of these things are impossible to know, there are safeguards you can put in place.
These will work for both of you because they don’t want to wreck their relationship with you on top of their financial problems.
Before you hand over any cash, you need to sit down with them and honestly talk about the situation. What the reason for them needing the money is and how their financial situation is overall. Being in debt can be a huge worry that affects every part of a person’s life so having someone to talk to about it can be a really big help too.
Before you make a decision, it’s considering the following questions with them:
Do they have a regular income?
How much do they earn?
What other financial commitments do they have?
What are their personal finances like?
Have they had trouble in the past repaying a loan?
Is there a better option for them?
The best way to make the arrangement as straightforward and stress free as possible is to be completely honest and ask these questions, even though it might be awkward. It’ll be a whole lot better to do this now, instead of when you’ve lent them the cash and things have gone sour.
There are lots of options available for lending money, and a guarantor loan is a more formal way of loaning money to family or a close friend.
It is arranged through a traditional lender, and you are named as the guarantor. This means you'll have to cover any payments they miss and you will need to repay the loan in full if they are not able to.
While this is a more formal arrangement, the issues still exist around lending to people you know and the problems that can occur if things go wrong. So before you sign on the dotted line, make sure you both fully understand exactly what you’re entering into, and what will happen if they can’t pay the money back.
You can compare guarantor loan rates here.
In the worst case scenario, you could lose your friend and you could lose the money you have lent to them.
You can’t demand they pay you back or threaten to repossess their house like a bank would if they don't make their payments. There's also no obligation for them to show you things like their credit score and you may just have to take their word when they tell you about their financial situation.
This is the risk you’re taking by lending to them, and if you don’t get your money back, this could reduce your own savings.
You can charge them interest to mitigate that loss, if you feel comfortable doing so. This would mean that you’re not losing out on interest that you might have been earning if the money were in a savings account instead.
If you choose to go this route, look at how much you’d earn on interest if you had the money in a savings account, how much interest a more traditional lender would charge them and then use this to work out an interest rate you’re both happy with.
There are a number of ways you can protect yourself against losing money and safeguard your relationship:
Agree between you how much you'll lend them
Discuss interest rates and choose one based on current savings rates
Set a timeframe for how long it’ll take them to pay you back
Agree how much they will repay each month
You must both be aware of all the terms and conditions before any money is exchanged.
A verbal agreement may seem fine – and in many cases it will work out with no issues – but to give yourself a little extra protection it’s helpful to have the loan agreement in writing.
This provides a record of the agreement should there be a dispute later down the line.
You could get an independent witness to sign the agreement too or hire a solicitor, especially if it’s a large sum.
Try to transfer the money via your bank instead of in cash, as that way there will be a record of the transaction and ask your friend to pay it back via a monthly standing order payment.
You can ask your building society or bank to confirm this has been done. This may sound formal, but it's necessary to protect yourself.
Keeping a record of all the repayments ensures there are no disagreements later down the line.
If you need to change your agreement, make sure you revise your contract. Both of you should again sign it in front of witnesses.
That way, if your friend needs more time to repay, you can keep track of exactly what has been agreed.
It may not be necessary to obtain collateral when loaning money to a friend. But it could act as an extra layer of protection if you're worried they will not pay you back.
Collateral is something of value given to you by the person borrowing the money. Technically you can sell this item to recoup the money if they fail to pay you back.
Anything can be treated as collateral, but it's usually something of sufficient value to cover the amount of money you have lent out.
You'll need to agree what you'll hold and when you can sell it. This should also be included in the written agreement.
If your friend struggles to meet the repayments as agreed, encourage them to be open and honest with you and to tell you.
It’s much better to know early on if they aren’t going to be able to repay you and this can not only save your relationship but you could change the terms of the repayment schedule so you’ll also still get your money back.
It may be that you have to extend the term of the loan, so they can spread out their repayments. Or, you could offer them a 'payment holiday' if their problems are only temporary.
In the worst case scenario, if they refuse to repay and you need to get your money back, you may have to go through the legal system:
If the loan is less than £5,000, you could make a claim via the small claims court.
If the loan is more than £5,000, you'll need to seek independent legal advice.
You can say no to a friend if they ask you for a loan.
It may be the case that you’re not comfortable lending them the money and you’re under no obligation to do so. However, this can also cause problems, especially if they’re in a bad financial position.
The best way to help them if you aren’t able to lend them money is to encourage them to keep talking about the situation. There are lots of free and independent charities and organisations they can speak to, who can give them financial advice.