In 2011, 60-year-old Neeraj Patel (not his real name) lent around Rs 20,000 to a close friend who was experiencing financial difficulties and needed money to start his own business. His friend had a good reputation, so Patel didn’t hesitate to lend his life’s savings without any formal paperwork. However, in the years that followed, Patel’s friend paid him double the Equal Monthly Rate (EMI) for two consecutive months, after which he stopped. Things took a turn for the worse when Patel’s friend passed away a few years later.
Almost a year later, after recovering from the shock of losing a dear friend, when Patel and his family turned to his friend’s son, who worked at a prestigious MNC, for money, they received no response. Patel soon realized that those savings had turned into a bad loan.
“The son initially agreed to meet me, but then did not show up for the meeting. After that, he wouldn’t even answer my calls,” says Patel.
You are clearly a “Good Samaritan” when you lend money to your friends or family in their time of need. But your “goodwill gesture” will be in vain if your efforts result in misunderstanding or financial loss.
Here are five do’s and don’ts to keep in mind when lending money to friends or family:
Ask yourself if you can afford it
You must first consider your own financial situation when a friend or family asks for money. If lending money strains your finances or you have to sacrifice a lot to manage your expenses afterwards, then you should avoid it. However, if you have enough savings or a large enough emergency fund and little or no debt, you might be able to help a friend.
Calculate interest and use collateral
“Money can be thicker than blood and ruin relationships. So, for the sake of the relationship, it’s better to get things straight from the start. We should keep our emotions under control as friends and family can take things casually. To avoid this, it is better to have a fixed interest rate and some security on the loan amount,” says Hemant Beniwal, director of Ark Primary Advisors, a financial planning firm.
Do you have a written agreement
This is a difficult, even cumbersome, matter, but a written agreement helps to avoid misunderstandings and clarifies responsibilities for both parties. The agreement gives you remedies in the unfortunate event that you later have to sue them to get your money back.
Don’t be guided by emotions
If you feel that your friend or family is really in need, you can borrow the money. But also consider the borrower’s ability to repay. If they work, find out how much they earn and what other financial commitments they have. Also try to find out if the borrower is responsible for the finances.
“Often people make loans based on emotion and don’t really treat those loans as serious outstanding debt. They tend to take these loans casually as there are no interest liabilities and legal complications are unlikely to arise,” says Beniwal.
Don’t feel obligated in money matters
Ideally, don’t lend money just out of a sense of duty. If the loan doesn’t make financial sense to you, drop it. Even if we are aware of a person’s liabilities or know that he or she has a bad credit history, we must accept that the borrower will most likely not be able to repay the loan. In this case, it is best not to lend at all. “Also, as a lender, you have a right to know what the money is being used for. If the reason seems illogical to you or if you feel that the person is simply taking out the loan to fulfill their desire for luxury, you should refrain from such transactions,” adds Beniwal.
While the decision to extend the loan is entirely yours, the above do’s and don’ts protect your money and your relationship with the friend or family member, which can be very valuable.