A few years ago, your brother borrowed money to help pay for groceries for several months, and paid you back. But now, he finds himself short of cash again and you’re not sure whether you want to lend her more money.
Wanting to help out a friend or family member when they’re in a financial bind may seem like a no-brainer, but you need to be sure you’re also taking care of your needs as well.
For one, you want to make sure you have enough room in the budget to pay for your own expenses — and lend money. You may also need to mitigate other risks, like potential strain on your relationship.
Let’s take a closer look at these risks and how to responsibly lend the money, if you choose to do so.
Emotional and financial risks of lending money
Even if you have extra money to lend to friends and family, you still want to be careful. Think about where you’ll pull the money from. Is it from sources like your emergency fund or money you’ve set aside for taxes?
Lending money that you may need yourself means potentially putting yourself in a precarious financial position. If the borrower doesn’t pay back your loan and you were relying on it, you’ll need to figure out how you can meet your financial obligations. It could mean taking out a loan yourself (and paying interest costs) or finding other ways to make up for the shortfall.
Even if you can afford to lend money, you risk your relationship becoming strained if the borrower doesn’t make payments as promised — or is unable to pay the loan back at all. It could get awkward at future social gatherings or even lead to feelings of resentment.
Still, you may decide that the risks are worth it or you’re absolutely sure the borrower will pay back what’s owed. Before handing over the cash, you’ll want to set some clear rules and guidelines.
How you can lend money responsibly
Before lending money, be sure you check that you can afford to. Setting clear expectations about the loans is also key.
Create a loan agreement
Creating a written loan agreement can help prevent any issues or miscommunication when lending money. At the very least, the agreement should outline the amount you lent and the repayment terms.
Other details you may want to put into the loan agreement could include:
- Interest rate, if you decide to charge one.
- Repayment amount and cadence.
- When the loan needs to be repaid in full.
- What happens in the event the borrower can’t repay the loan.
Share this document with the friend or family member before lending the money. That way, they can decide whether to agree to the terms. Having open and honest communication from the very beginning ensures that everyone can address questions or concerns about the loan.
Though it may cost you some money, having this document notarized signifies that you take the loan seriously.
Understand any tax implications
You are not required to charge interest on loans to family and friends in Canada, even if it does exceed $10,000. However, it is advisable to do so to avoid any dispute down the road
Interest you collect counts as taxable income. It is up to you to determine how much interest you want to charge.
Be OK with saying ‘no’
Even though it’s an uncomfortable situation, you need to be prepared to say ‘no’ to requests to lend money to family and friends.
At the end of the day, you need to look out for your best interests. It may not be worth risking your financial security to help someone else, especially if it means you could be left in dire straits. Not lending to friends or family because you don’t want to risk ruining the relationship is also a perfectly valid choice.
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
