When it comes to our friends and family, many of us would do anything to help them out, even if it means offering financial help. Many of us find it hard to say no when it comes to lending money. And then we are terrible at asking a loved one to return it if they haven’t yet. When it’s a small amount, we may find letting go of it easier, but when it’s a lump sum, how do you ensure you won’t incur losses due to kindness?
Due to such complications, many people decide to never let monetary transactions become a part of their friendships. They refuse to lend or borrow from a friend. It’s a dilemma, and honestly, there is no right answer. Should you lend money to a friend or a family member? And if you do, how do you also protect your interests?
Analyse your financial health to know how much you can lend
Although you want to help your loved one, you can’t do it by risking your own financial health. This means you need to thoroughly understand your financial situation and upcoming expenses, so you don’t go broke by helping another person. “Evaluate your financial health or financial situation by analysing your savings, your net worth, your debt-to-income ratio, your short term and long-term financial goals, your retirement funds, your insurance plans, your investments and your monthly/ annual budgets,” Sai Bhosale, a chartered accountant and financial advisor explains.
One should also keep in mind that if in case the borrower is not able to repay the loan, it doesn’t wreak havoc in your life financially. “You must lend only as much as you are comfortable to part with as the chances of repayment by friends or family members are slim. Non-repayment of loans should not be a cause for your financial strain,” Bhosale points out.
Make a loan agreement if the amount is big
You must lend money only to those individuals, who you think will be able to repay in EMIs or via whatever arrangement you have. Even then, it is important to make a loan agreement, so it is all on paper.
“To protect your money, it is desirable to draw up a loan agreement irrespective of your relationship with the borrower and not rely on a verbal promise. This agreement should be printed on a stamp paper and should be attested by a notary,” Bhosale advises.
Bhosale lists down the elements a loan agreement should include.
· Full names of borrowers and lenders
· Date on which the loan was granted
· Amount borrowed
· End use of the loan amount taken
· Collateral, if any
· Interest rate and amounts (if applicable)
· Repayment terms and schedule
· Consequences, in case of default by the borrower
· Termination Clause
· Clause to include legal heirs, in case of death of borrower or lender
· Signatures of both parties and witnesses
Maintain repayment records
There shouldn’t be any confusion on how much is already paid and what amount is pending. Payment records will work as a safety net for you, should the situation go sour. “Apart from the loan agreement, a statement showing monthly or annual repayments towards principal and interest and reflecting outstanding balance due should also be maintained. In case of any litigation, the loan agreement and the loan statement form part of documentary evidence to prove that the loan is legitimate,” Bhosale explains.
Be careful if you are co-signing for a loan to help them
Sometimes, a loved one may seek your help by asking you to co-sign for a loan. This could be because you have a better credit score or you can help them get a bigger amount. However, this can be quite risky and you should know what you are signing up for.
“A co-signer is a person who applies for a loan together with another person and agrees to pay off the loan if the primary borrower defaults. He or she is a financial guarantor, does not receive any loan proceeds, and has no title or ownership in property for which loan is taken,” Bhosale explains.
“Irregular payments or defaults in repayment of the loan by the borrower can impair your credit score too. Also, since it is a debt, you are legally obligated to pay, so when you go to apply for another loan in your name, it may be difficult to get approval. A co-signer must be aware that he can be released from the contractual agreement only if the borrower and lender both agree. The lender needs to be satisfied with the repayment capacity, credit score and history of the borrower,” Bhosale points out.
How can you protect yourself from losing money when lending it to someone?
If you have decided to lend money, then you should do so by being careful. Here’s some expert advice by Bhosale to help you protect yourself from losses.
· Understand the end use of the loan and the creditworthiness of the person.
· Do not lend money in cash. Make use of an account payee cheque, account payee bank draft or transfer money by using an Electronic Clearing System (ECS) through a bank account.
· Charge some interest on the loan given so that if the principal amount is not repaid wholly, you at least receive some interest.
· Request for some security against the loan.
· Treat the loan as a gift and give only how much you can afford to lose.
· Enter into an agreement with the borrower and document the same.
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