What do you do if a friend or loved one asks for a loan? Here are some points to consider.
Warning: This article is about how to lend money to a relative the right way. However, it doesn’t guarantee that you’ll get repaid. Proceed with caution.
As the economy continues a long slide back into recession, many families that haven’t faired as badly as others are receiving an awkward request from relatives and close friends: loans. Loaning money to a loved one is a tricky thing. Once the request is made, it’s very difficult to come out a winner. If you decline the request, then you’ll be branded as greedy or selfish instead of the prudent person you are. If you agree to the request, then you run the risk of not having the loan paid back. The borrower may also assume that you’ll display a certain degree of flexibility that any other lender would not. When you do enforce the agreement then you’ll also look bad. It’s one of those things that seldom work out.
If you do decide to proceed with a loan, consider the following recommendations to minimize problems down the road.
How To Loan Money To Family or Loved One
Execute a written contract
Verbal agreements never end well. The human memory isn’t perfect. It’s highly unlikely that two individuals are going to remember exactly what was agreed to several years later. This may sound obvious, but millions of verbal loan agreements still take place every year. It is extremely difficult to prove, much less enforce, the terms of a verbal loan agreement.
The most reliable option is to work with an attorney to draft loan documentation and secure notarized signatures. Of course, this is the most expensive option but is worth the investment. Other options include websites like lawdepot.com and nolo.com, which sell standard loan documentation with minimal customization available for a relatively modest fee. You can also engage a service like Virgin Money. In addition to providing the loan documentation, Virgin Money will also facilitate electronic payments via ACH debit and much more. The Virgin Money services start at $99.
Request collateral to secure the loan
It’s entirely reasonable for you to request that the loan be secured by collateral. The collateral should be worth more than the amount being lent. It’s not enough for the borrower to own something of value. You need to legally perfect the collateral. This process in effect puts title to the collateral in escrow, usually held by an attorney. If the borrower defaults, you can go directly to the attorney to take possession of your collateral. Perfecting is very powerful. Once the collateral is perfected, your claim to the collateral is superior to someone else who may file a lien against the property being used as collateral. It also survives a bankruptcy filing by the borrower.
Charge sufficient interest
If you think you are doing someone a favor by charging them zero interest on the loan it may cost you more than you think. A below market interest rate could be seen as a gift instead of a loan, triggering gift tax issues for the lender.
