If you are lending money to a family member or friend, you go in with the presumption you will be paid back. To increase those odds, it is important to critically look at every aspect of the loan and treat it as a business decision, not a personal one.
To best protest your investment, these are important decisions that should be made around the loan. This protects your interests as a lender and helps protect the borrower and relationship by setting clear expectations up front.
Many friend and family loans are very informal. This stems from the long relationship history and a mutual trust between the two parties. That trust and relationship is important, but leaving everything informal can lead to two different sets of expectations and a strained relationship.
Whether you are giving money to your own child or a long-time friend, setting clear, written expectations is vital to protecting your funds and ensuring both parties agree on the terms.
Never, under any circumstances, give a loan without a contract. If you do lend money without a contract, consider the money a gift and drop any reasonable expectation of getting your money back.
Loan Terms: Interest Rate
Interest is how banks, financial institutions, and investors earn a return on their money. If you were going to put your money into any investment, you would expect a return on investment for the risk you are taking. Family and friend loans can work differently, but do not have to work differently.
If you are lending to someone having a tough time financially to be supportive, it could make sense to forgo interest. However, if you are lending money to someone to help them start a business or make a large purchase, it is reasonable that you would expect some sort of compensation.
For example, if you are lending someone money to start a new business, you are an investor in the business. Don’t think of the interest as something squarely on your friend’s shoulders. Instead, think of it as a return on investment from the business you helped fund.
Remember, if the borrower were to take out a home equity loan they would pay an interest rate around 5%. If they borrowed using a credit card, that interest rate could easily be over 20%. Even from a peer-to-peer lending service, interest rates can reach nearly 30%. If you can help them save money and make a little something yourself, it is a win-win.
There is no right or wrong answer here, it depends on your relationship and goals. Follow your gut instinct and work together to find the best option for your situation.
Loan Terms: Payback Schedule
If you lend someone $7 for lunch, you will not miss the money too much if you don’t get paid back. If you give lend someone $700, not getting paid back is a much bigger deal. If you lend someone thousands of dollars, getting your money back is even more important.
When you setup a new loan, do a little testing to decide the right balance between payback period and monthly payment. A very short payback period leads to a higher monthly payment. A longer payback period leads to lower monthly payments. With MoneyMola, you can choose weekly, bi-weekly, or monthly payments to help best match borrower needs and cash flow to payments. I suggest making an automatic payment each payday rather than a big lump once a month.
Whatever you choose, get it in writing and setup a plan to get paid back on a reasonable schedule.
Set Your Loan Terms with Money Mola
With the tools at Money Mola, you can choose each of these vital loan terms and generate a contract with no extra hassle. Each new loan gives you the powerful lending features of a bank with a simple, easy-to-use interface.
Every loan gets a contract and gives you the option to set the interest rate, payback period, payment schedule, and more through our advanced loan features. The next time you are going to lend someone money, protect your cash, relationship, and get paid with an automated direct deposit with Money Mola. We’re here to help make family and friend loans safe and simple.