When your best friend views your nest egg as a source of
start-up funds for his latest business venture, or your nephew hits you up for
a car loan, your first impulse may be to reach into your bank account to help.
But it's a fact that loans to family and friends often end up straining both
finances and relationships. As Shakespeare said, "Loan oft loses both
itself and friend." In other words, if you lend money to friends, you
often don't get paid back, and the friendship itself may disintegrate.
It's best to consider a loan to someone you love as an
"arm's length" transaction. If you're pondering such a loan, keep the
following in mind:
* You can just say "no." It's your money, after all.
Do you really want to raid an emergency fund or dip into your child's college
account to finance a friend's business idea? Think like a bank. It's reasonable
to ask tough questions about the person's bank accounts, potential sources of
income, planned use of loan proceeds, and spending habits before extending
credit.
* Consider a gift. If you're comfortable sharing your
resources, you may want to provide a monetary gift with no strings attached. In
many cases, this is the best solution because neither you nor your friend
expect the money to be paid back. Unlike a loan, this type of arrangement can
forestall misunderstandings and hurt feelings later on. Of course, you should
not give money if doing so would unduly strain your own finances.
* Formalize loans. If you decide to lend more than a small
amount to a friend or family member, it's generally best to draft a written
agreement. This can be as simple as filling out a promissory note (available
online or at office supply stores). Such forms spell out the basic terms of the
loan -- amount, interest rate, payback period -- and provide some limited
protection should you and the borrower end up in small claims court. Another
recent innovation is the use of direct lending (also called social lending or
peer-to-peer lending) websites to facilitate loans between family and friends.
For a fee, such sites can prepare loan documentation, send payment reminders,
issue regular reports, even facilitate electronic fund transfers. If the loan
involves a significant amount of money, check with your attorney.
Remember: Many personal relationships have been damaged when
loans go awry. So proceed with caution.
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