1. Lending money to friends? Here’s what you should know

Lending money to friends? Here’s what you should know

The trust you have in your friend would be the first casualty when you approach the delicate subject of repayment.

By: | Published: June 21, 2016 10:27 AM
Financial planning: Lending to friends Lending to a friend: You may feel bad turning down a friend’s request for money. But it is absolutely essential to your own financial health that you say ‘no’ if your finances don’t allow you to lend. (Photo: AP)

In Hamlet, as Laertes is ready to start his journey to France, his father Polonius gives him an advice for the age. “Neither a borrower nor a lender be,” he says, “for loan oft loses both itself and friend” – do not lend to or borrow from a friend, for you will lose both the money and the friend.

Money between friends is a delicate subject. Handled without due care, it has the power to damage relationships. Here, we take a look at how we can navigate these tricky situations and how best we can safeguard our financial interests as well as relationships.

Why is it so complicated?
Once you lend money to a friend, you may find the equation changing. Your friend may become conscious of the fact that he is in your debt therefore he needs to treat you with greater respect.

In a normal case, a transaction between friends would not be governed by a legal agreement or the need to repay principal with interest. It is transaction based on trust. You believe your friend will repay you within the agreed period of time. He may not always correctly assess your own financial condition, therefore he may sometimes take longer than expected to repay you. When money has been lent in the absence of any terms and conditions, the friend may not be motivated to return the money.

The problem doesn’t end here. Your friend may want a repeat loan, pulling you deeper into a lending trap. If you say no, there’s a chance of your previous debt going bad. If you say yes, you’re stretching your own finances.

The trust you have in your friend would be the first casualty when you approach the delicate subject of repayment. Maybe your friend will pay up. Maybe he will ask for more time, or reluctantly make a partial payment. These are unpleasant situations that can strain your friendship.

Hence lending and borrowing between friends must be handled with due care, keeping in mind the following points.

Saying No
When a friend asks for a loan, prepare yourself before saying ‘yes’ or ‘no’. Think of the impact on your relationship saying ‘no’ would have. Secondly, think of all the avenues through which your friend can raise money: personal loan, loan against property, loan against gold, overdraft on FD or borrowing from private financers are just a few options you could suggest to him. If any of those options work out, you can avoid becoming a creditor to your friend.

Saying Yes
If you must lend money to your friend, prepare yourself for the consequences and start thinking about the terms of the loan.

Estimate the spare money in your hand after paying all the EMIs, debts, dues for investment instruments, insurance premiums, monthly and sundry expenses. Try to assess the exact fund requirement of your friend and enquire about the purpose for which he requires the money. It is very important at this point that you lay down all the conditions for lending. Explain to your friend that you would require money back within a specific time period (e.g. six or eight months).

Suggest that returning the complete fund at once could be difficult for him, therefore he can pay back in monthly instalments.

Forming an agreement
Insist on a written agreement or note. Try for a legal agreement or a promissory note on stamp paper, if you are comfortable. Mention details such as the loan amount, tenure, return conditions, and interest (if any) to document the transaction and safeguard your interests. You could consider discussing the arrangement in front of spouses and family members, and ensure there are witnesses to the handing over of the money. Now, there is complete transparency to the transaction, and won’t be any confusion about the terms of the loan. In case you’re no longer around to reclaim the money, your spouse or family members will not be in the dark about the details of the loan and can reclaim it when it is due.

Know Your Limits
You may feel bad turning down a friend’s request for money. But it is absolutely essential to your own financial health that you say ‘no’ if your finances don’t allow you to lend. You must refrain from over-leveraging your financial position for trying to be a good friend. It is a bitter but sensible decision to protect your own finances.

Tax Impact
If you receive any interest on the money given to your friend, that amount would be liable to income tax according to the appropriate slab.

Under a dispute, you can seek legal support only if there is a written agreement or a promissory note on a valid stamp paper with proper signature of both the parties and duly notarised. The payment should be given through an account payee cheque for a better legal binding.

You can also ask your friend to give post-dated account payee cheques (in your name) to repay the borrowed amount in instalments. If he fails to honour the cheque on the respective date, you can invoke an immediate legal action.

One Final Advice…
Bringing money into a friendship is complication that is best avoided, or handled with due care. Nevertheless, it’s a complication we will encounter many times in life. Therefore it is advisable to have a plan and set your own rules for dealing with the friend in need. How about setting up a contingency fund just for him?

The author is CEO, BankBazaar.com.

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