No good deed goes unpunished.
Clare Booth Luce, in H. Faber, The Book of Laws, 1980
US diplomat, dramatist, journalist, & politician (1903 – 1987) (Source)
I’ve seen it happen often: a family member, friend, or even friend of a friend comes to you with a sob story like “my cat is sick” or “I need money to pay my bills.” Your quick wit tells you to spout out “Sell that 60 inch LCD television that you’ve got hanging over your fireplace!” but you bite your tongue. Lending money to family or friends is a dicey situation, and it when it goes wrong, it will change your relationship.
“I Don’t Care What You Think. S/he’s My Friend, and I’m Going to Help Them.”
If you’re going to ignore your gut instinct, loan as much as you’re willing to lose and don’t expect to get paid back. If you do get paid back, just think of it as a bonus. You can also take further precautions by considering the following:
Get it In Writing
Have you ever heard the phrase “It’s not worth the paper it’s written on?” Well, it’s far harder to prove an oral contract than a written one, so make sure you document your agreement in a promissory note, which includes the interest rate, repayment schedule, and default terms.
And just because your credit card can charge you a 29.99% interest rate, it doesn’t mean that you can; each state has their own usury laws and a maximum interest rate one can charge.
Consider a Getting Security
The worse type of person to lend money to is someone who is judgment proof: even if you sue and win, they’ve got no assets for your to collect on. However, if they have things of value, like interest in real property, jewelry or a perpetual motion machine, think about having the borrower put up those items for collateral to securitize your loan. That way, if the borrower fails to pay you back, you may be entitled to the property. If secured by real property, consider getting a deed of trust with power of sale.
“I Swear, I’ll Have the Money Next Week.”
The first date for payment comes and goes. On the second date for payment, borrower only gives you half of the payment due. And then the check bounces, and now you’re hit with bank fees. You’ve tried to be nice, and now you’re out a bunch of money. So now that the borrower has defaulted, what do you do? I do not suggest breaking someone’s legs, but now you’ve got a decision to make: do you try and get your money or try to preserve the status quo and your relationship? That is a personal decision only you can make.
Bottom Line
Only lend out money you’re willing to lose. Even if you get paid back through the collateral, your relationship would change, most likely for the worse. Easiest thing to do is to not lend out money, but if you’ve got to do it, make sure you’ve protected yourself. If you need help, consider contacting an attorney to assist you drafting your promissory note and/or collecting on the note.
Want more? Personal finance blog fivecentnickel.com has a post about lending money to family and friends.
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Dan X. Nguyen is a business attorney in Orange County, California, and he is proud of those people who securitize the promissory notes they sign. Information on this site is for informational and educational purposes only; it does not constitute legal advice nor does it create an attorney-client relationship. Should you need assistance, please contact an attorney to help you with your specific set of facts.
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