If you’re thinking about loaning money to a friend or family member, there are some important things to consider. The most obvious thing, of course, is what happens if they don’t pay you back. And how do you preserve the friendship if that actually happens!
But there are other sticky issues that may get attached to the deal. Issues a contract can help. What if they don’t make all the payments on time. Or start to miss a few. And what if you start realizing that the two of you have a different picture of what’s expected?
The best solution when loaning money to a friend
As much as you’d like to leave it to trust and friendship, a formal contract is the way to go. It can save a lot of headaches and misunderstandings. And a written agreement can clearly spell out all the “what ifs” that might blow up down the lending road.
If you’re thinking “I can’t ask a friend or relative to sign a contract!” Well, as hard as that might seem, won’t asking them later on why they stopped paying be even harder? “But they won’t stop!” you want to say.
You may be right. But with a contract that you both understand, you have all the potential misunderstandings clearly spelled out. And it’s all done up front while everyone is feeling good about it. Plus, it’s so much harder to address problems later on when people are feeling guilty or taken advantage of.
Potential issues that might pop up
If you don’t go the contract route, a lot of things might happen. Even to the best of friends. Some of these things include:
- Late payments
- No payments
- Stopping payments because you have a fight
- Seeing your friend waste money (especially if they pay you late)
- Feeling like you’ll never get your money back
- Thinking about what you could be doing with your money instead
What about charging a friend interest?
You might think it’s best to make the loan without interest. This is your friend after all. But, it’s a smart idea to keep this as a business arrangement. And that means you charge a reasonable interest rate.
This way you are making something on your money. And your friend really gets that this is a formal business arrangement, interest and all. In a way, it solidifies the deal. Also, it helps your friend feel they’ve given you something in return that’s fair. A real win-win.
What if your friend resents the contract?
Of course, that’s always possible. You need to decide if this should get in the way of loaning money to a friend. But I will tell you that I did this with a good friend. And it kept the whole arrangement feeling clean and issue-free. And when he finally made that last payment, it felt great for us both!
Amortization Schedule Calculator Link
Every time you make a loan payment, that payment pays off part of the loan. And it also includes a portion of the interest you’re paying. Amortization is the accounting process that allocates the right amount of each part (principal and interest) as the loan continues.
You can find a great amortization calculator by going to: Bankrate.com. Although it says it’s for mortgages, you can use it to calculate your monthly loan payment. And it also gives you an amortization chart that details every payment date and amount left as you pay off the loan.
I created a sample 3-year, 3% loan agreement to help you think through your own contract. But there’s also a sample amortization table that gives you a picture of how the loan and interest are paid off. You’ll see it dwindle, bit by bit, over the term of the loan.
Sample contract when loaning money to a friend
In order to help minimize conflict, this 2-page contract directly addresses several possible issues that might arise. Some of the areas covered are missed payments, late payments, and early repayment.
There’s even a way to insure yourself just in case something happens to the person you’re lending to. That may sound horrible, but it can minimize problems should the unthinkable happen.
SAMPLE LOAN CONTRACT
NOTE: Please click on each page to see them more clearly in a new window
[You may need to enlarge the screen by zooming in.]
SAMPLE LOAN AMORTIZATION TABLE
Again, please click on amortization table to see it more clearly in a new window.
Not everyone is going to go the formal route. I know that. But, I can assure you that any effort you put into creating a contract can go a long way to making the loan itself easy and issue-free. Or at least as issue-free as any loan between two people can be.
At the very least, I hope this post helps if you think things through. If you ever do wind up loaning money to a friend. Good luck!
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