Is lending to friends or family a good idea?

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 a bank.

However, although you may want to help them, you need to put your financial wellbeing first. If things went wrong, 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:

Can you afford it?

Decide whether you can afford to part with the cash, its not simply a case of whether you have the funds in the bank as you will not get the money back for months to come.

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.

Can they afford it?

Why do they need it?

If they need money to pay for car repairs or a replacement boiler, you may feel more inclined to lend than if they want to book a cruise.

If they are reluctant to say why they need to borrow, remember it is your money and you are well within your rights to ask what it will be used for.

Decide 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.

You should consider:

  • If they are working

  • How much they earn

  • What other financial commitments they have

  • How effectively they have managed their money in the past

If they do not have much money coming in and are already struggling to pay their bills, another loan might not be what they need. If others have lent them money and struggled to get it back, you may want to be more cautious.

You could end up losing your money and your friend as they are unable to pay.

Is a guarantor loan a better option?

If you would like to help but are unsure whether to lend money to your friend directly, you could consider helping them get a guarantor loan.

This is where they borrow money but you guarantee to make the loan payments if for any reason they are unable to do so. You can compare guarantor loan rates here.

Will you lose out by lending?

If you take money out of your savings or reduce the amount you are paying off your mortgage, you would technically lose money by lending to your friend.

Although it can seem harsh, if you do not charge them any interest you will essentially be paying for the privilege of lending your own money.

Consider asking for an amount equivalent to that which you would have earned if the money remained in your savings account.

Protect yourself

If you decide to lend the money, there are a number of ways you can protect yourself:

Set the terms

Before you lend the money make sure you agree exactly:

  • How much you will lend

  • The interest rate

  • The term

  • How much they will be expected to repay each month

It is essential that you are both aware of all of these conditions before any money is exchanged.

Write a contract

Drawing up a written agreement or contract which lists all the agreed terms of the loan makes it clear what you are agreeing to, and 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 is for a significant amount it may be worth getting a solicitor to help you do this or asking the Citizen's Advice Bureau to talk you through it.

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 bank transfer or even cheque; this will ensure that there is a record of the payment that can be easily confirmed in future.

If you decide to clear a debt or bill directly on their behalf, make sure that you get some form of confirmation of payment.

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.

Record repayments

Once 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.

Keep your agreement up to date

If you need to change your agreement, make sure you revise your contract accordingly. 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.

What if things go wrong?

If your friend struggles to meet the repayments as agreed, 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 they refuse to repay and you need to get your money back, you may need to go through the legal system.

  • If the loan is for less than 5000, you may be able to make a claim for the money via the small claims court.

  • If the loan is for more than 5000, you will need to seek independent legal advice, to find out how to try and get your money back.

Are there any alternatives if you say no?

If you decide that lending to your friend is simply too risky or that you cannot afford it, they will need to raise the funds another way.

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, they could try to get a loan elsewhere, although reading our guides could help your friend or family member understand what kind to go for: