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5 Best Ways for Making Loans to Family and Friends

Money Girl explains what you show know about giving, lending, or borrowing when it involves family or friends, so you can protect both your finances and your long-term relationships.   

By
Laura Adams, MBA
7-minute read
Episode #381

Way #2: Make a Personal Loan

If you have cash to spare and want to make a loan to someone, there are several considerations. One is that making a no- or low-interest loan that’s $10,000 or more could make you subject to the gift tax, if the rate you charge is less than the going market rate.

Another huge issue is what happens if the borrower can’t or won’t repay you. The key to making a successful loan is to feel confident that the borrower has the ability and willingness to repay you. Likewise, it’s unethical to take a loan from someone that you can’t or don’t intend to repay.

To make sure both parties are clear about payment expectations and terms of a loan, always have a signed and recorded loan document, known as a promissory note. It protects you if you need to sue someone for repayment - but note that going down that path always takes time and money, and will probably ruin your relationship.

To make sure both parties are clear about payment expectations and terms of a loan, always have a signed and recorded loan document, known as a promissory note.

However, the upside to lending is that you could receive a good return on your money, depending on the interest rate and terms you and the borrower agree to. I’ve loaned money to friends for short-term business needs that turned out to be win-win transactions. My friends got the capital they needed quickly, and I earned an interest rate that matched or exceeded what a bank would charge for a similar loan.  

Use a site like Rocket Lawyer or LegalZoom to create a loan document that puts the amount, terms, interest rate, and late fees in writing.

See also: 5 Ways to Get a Loan with Bad Credit

 

From the borrower’s perspective, the main downside to getting a loan from a family member or friend is that you give up the opportunity to build credit. That’s because your payment won’t be reported to the national credit agencies.

Of course, having no or poor credit is a common reason why you might get turned down for a traditional loan, and consider turning to family or friends in the first place.

Way #3: Co-Sign a Credit Account

Another common way to help someone with no or poor credit is to co-sign a joint credit account, such as a personal loan, car loan, or credit card.

Co-signing a credit application means that you and the other borrower assume equal responsibility for the account. Both of your credit histories will be examined, but a good one can outweigh a poor one, on balance.

If payments are made on time, it can be a win-win, because both co-signers will build or maintain good credit. However, if payments aren’t made on time, both co-signers are on the hook for the entire debt (not just half of it), even if the other person was the big spender.

Being fully liable for someone else’s debt could ruin your credit if you can’t repay the full amount on time. So never co-sign any type of loan or credit account without understanding that you’re completely responsible if the other person doesn’t hold up their end of the deal - or worse, dies.

Also, be sure to monitor a co-signed account regularly by viewing it online, or getting paper statements in the mail, to make sure that payments are being made on time every month.

See also: Best Tips to Improve Your Credit Score

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About the Author

Laura Adams, MBA

Laura Adams received an MBA from the University of Florida. She's an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura's previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.