How to approach lending money to family and friends

When a friend or family members asks you to loan them money, it can be a precarious situation. You know the person and (hopefully) believe their best intentions, but don’t want to let money ruin a family relationship. Even if the amount doesn’t seem large, and it’s for a close relative, it is probably best to treat the loan as formally as possible. Keep these tips in mind to effectively loan money to family or friends.

Put the Agreement in Writing
Documenting the loan properly can help prevent cases of fraud, or having the borrower skip town on you. Even if you are confident in the borrower's ability to pay the loan back, Forbes recommends including “a timeline for repay[ment]…a payment schedule, and what happens if the loan goes unpaid [1].”

It's a good idea for both parties to sign the documentation, and if you want even more security, you can have document notarized. This agreement ensures that both the lender and borrower are on the same page with the financial agreement.

Charge Interest
If you are lending your friend or family member a significant amount of money (say $10,000 or more) then you will definitely want to charge them interest to avoid tax implications [2]. Money given without interest charged is considered a gift, and the IRS has limits on how much money can be gifted to a single person in a one-year period. Charging interest, even at 2 percent, a rate well below market value, prevents the amount from turning into a gift.

Only Make the Loan if You Can
If you're considering lending a family member money, be ready for the possibility that you may not get your money back. This isn't to say that you shouldn't trust the borrower, but be prepared for the fact that they may not pay you back. Investopedia recommends “go[ing] into a family loan situation with a mindset that you'll never see the money again [3].”

This mindset will allow you to determine whether or not you can actually lend the money, or if you need it for your own personal needs. If you can accept never seeing any of that money again, then you should go ahead and make that loan.

[1] Seven Tips for Lending Money, Forbes
[2] How to lend money to family members, Real Simple
[3] How to Lend Money to Family and Not Regret It, Investopedia