If a loved one asks you for money, you must handle the situation correctly. This can mean knowing when to use a promissory note, for example. With this in mind, here are the eight main steps for lending money to friends or family.
1. Hear the Reason
Before saying yes, listen to your loved one. Ask questions about why they need the money. Is it a lot? And if it is, does their reason line up? If not, they may be keeping something from you.
This also lets you learn more about their current situation. You’ll then find out if they can actually repay the loan, which can really affect your final decision.
2. Check Your Finances
Look at your accounts and see how much you can comfortably give. Only loan out what you can afford to lose, however. You must prepare for the possibility that you won’t get the money back. This is the case even if you trust your loved one completely.
If you can’t comfortably lend the full amount, be honest. Your loved one will know that it isn’t personal. No matter how much you want to help, don’t violate your own boundaries. You’ll have to consider the consequences and opportunity costs.
3. Set Clear Terms
Discuss the loan’s terms with your loved one. This may include the specific amount, the interest rate (if applicable), and the repayment schedule. You must also confirm the payment method you plan to use. It’s also good to be firm about them only spending it on essentials.
On the topic of interest, you might forego this entirely. After all, they might be someone close to you. If you go ahead with it, make sure it’s fair. A fee for late payments also isn’t out of the question.
4. Use a Promissory Note
A promissory note is a document that sets out the lending transaction. It also includes any terms you set for repayment. You can use this as proof of the debt in the future, should the need arise. With a “secured” note, you can claim collateral in return for unpaid debts.
To stand up in court, here’s what your promissory note has to include:
- The lender’s name
- The borrower’s name
- The repayment plan
- Details about interest rates
- Collateral (if applicable)
- Consequences for late payments
A promissory loan template already comes with these fields. All you need to do is fill them in with the right details. If you’re on a budget, free online templates can help.
5. Figure Out Tax Implications
The specifics of your situation can affect tax. Generally speaking, the IRS doesn’t treat personal loans as income. However, if you’re lending a large amount, it might be subject to gift tax. This is more likely if you don’t charge interest.
The IRS gift tax threshold is $18,000. So long as you don’t exceed this, you won’t need to report the loan to them. If you cancel the loan, though, it can count as cancellation of debt income. You must specifically class it as a gift to avoid this.
6. Stick to a Repayment Schedule
Your initial discussions and promissory note should outline repayment terms. It’s important to stick to these. If you let them pay an installment late, they may continue to do so. Give reminders of upcoming repayment dates without being aggressive.
Choosing between repayment types can be difficult. Find a practical amount/frequency that both parties are okay with. In their situation, a lump sum possibly won’t work. Monthly fixed payments might be much less stressful for them.
7. Prepare for Changes
Life is unpredictable. Your friend or family member might be unable to repay your loan on time. This means a grace period is often necessary. Penalties may not kick in until 5-10 days after the due date.
If, for example, their job pays them irregularly, consider changing repayments to fit this. Once again, it’s possible that they won’t be able to pay you back. If this is the case, consider if you can forgive the debt.
8. Check In Regularly
To make sure everything goes smoothly, you must communicate with each other. In addition to a clear repayment schedule, set up regular check-ins. This will give them a space to talk to you in case they’re struggling debt-wise.
You’ll also be able to discuss issues before they arise. For example, you won’t have to wait until the repayment day to learn they can’t pay you. If it’s a one-time situation, you could extend your grace period.
Conclusion
Lending money to friends or family could harm your relationship with them. That’s why you both need to agree on everything in writing. With an online template that holds up in court, you’ll have peace of mind about the process.
