Helping out a friend in need is a great gesture, but it is wise for your financial health to ask a few vital questions to yourself before lending money to a friend.
“A friend in need is a friend indeed” – but when it comes to money matters, it is always advisable to do some introspection. While saying a “NO” could bring in some uneasiness in your friendship, saying a “YES” and regretting later is not a wise decision either. Hence, one should ask themselves a few important questions before lending money to a friend.
Why Does Your Friend Need That Money?
Like financial establishments, it would be wise to ask your friend the purpose of the money needed. It’s your hard earned money and cannot be easily handed over to someone because they are in need. Ask your friend about every detail, including the need and purpose of the money to be lent. If he refuses to give out details, then take cues from it and step back. And if he provides a satisfactory response with logical payback plan, then do some math at your end before helping him out.
What Other Debts Does The Friend Have?
Analysing this is vital before you lend money to your friend. It may be because your friend has exhausted all other sources of borrowing and hence approached you for the money, which means that his Credit Card limits must have drained out and possibly various Loan (home, car, and student) payments are yet to be paid. In that case, it won’t be easy to repay the borrowed amount to you anytime sooner.
Does Your Friend Have The Potential To Pay Back?
You might not have a direct answer to this question, but a close observation can reveal the answer to this. It could happen that he/she is in need of money for a specific instance while he has a well-set job or business from where regular cash flow happens. Also, his spending pattern will give cues to the money he saves and hence would give indications of whether he has the potential to pay back or not.
Can You Afford To Lose The Money?
Professional lenders apply various techniques to assess loan risks and sometimes can absorb the bad loans cost from money they make through the interest on good loans. As an individual, it becomes difficult to analyse it and in a worst case scenario how much can you afford to write off. It is thus advisable to lend out part of the money asked for as a borrowing amount.
Should You Charge Interest?
Charging interest again doesn’t mean profiting at your friend’s expense but then there is an inflation cost and opportunity cost that goes in. And hence a minimum amount of interest can be charged for recouping the cost of having the money unavailable to you for a while.
Should There Be A Formal Agreement?
Even though the transaction is between two friends, there’s nothing wrong in formalising it with a signed agreement. It brings in more clarity in laying down the terms and conditions and the entire dealing becomes transparent. In fact, a true friend would appreciate such a move.
What Impact Will It Have On Your Income Tax?
Interest-free loans are non-taxable to both borrowers and lenders. But in case there is a provision for interest payment between both the parties, the lender has to pay tax on the interest earned in that particular financial year. Since loans to friends and family members are non-institutional, they are not eligible for tax deduction under section 80C.
How Will This Loan Affect Your Relationship With Others?
The loan might directly or indirectly invite some trouble in the family. Your spouse might not approve the act and might be upset with it. You might be seen as a financial saviour in your friend circle and lending to friends may become a regular feature. You surely don’t want this to happen.
At the end of the day, it’s your money and you should analyse well before saying a yes or a no before lending money to a friend.