Credit Sesame advises on what to ask yourself before you lend money to a friend.
Can you lend me a grand?
It’s a question that can make you freeze like a deer in the headlights. A friend asks to borrow money from you. Not just to spot them a $20 bill on a night out. They want a meaningful amount, certainly more than you can casually pull out of your wallet.
You find it tough to respond because you are on the spot. You feel like you are being forced to choose between your friendship and your finances. As the question hangs in the air, you feel pressure to break the awkwardness by saying … what, precisely?
That’s where you should stop to ask a few questions first. You are sure to make a better decision if you have more information, plus it gives you time to think. Discussing it in more detail may make your friend think about whether they should be borrowing this money.
Even if your instinct is to lend money to a friend without asking questions, it’s wise to stop and think. If someone feels close enough to you to ask you for a loan, they should feel close enough to share some background on why they need the money.
1. How would it affect you if they cannot repay the loan?
This is more a question for yourself than for your friend, but it may make them pause for thought if they understand how meaningful the amount of money is to you. Consider how significant a burden the loan would be on your finances, and let your friend know.
It’s important not to position this as if you don’t trust the person. You should not consider lending them money if you don’t trust them.
Instead, it’s just a practical “what if” question. Banks and other lenders essentially ask themselves this question every time they make a loan. They need to understand the worst-case scenario to determine whether or not to make a loan, how much to lend, and what conditions to put on the loan.
You should do the same sort of risk assessment. A Credit Sesame survey found that of people who reported they had borrowed money from friends or family, 43% said they could not pay it back. So, the risk of not getting paid back when you lend money to a friend is genuine.
Ultimately, you should assume the worst before you decide to lend someone money. If losing the money would seriously hurt your finances, don’t make the loan.
2. Why does the person need the money?
Does your friend have a good reason for needing the money right away? How important is that need, and is it something they should be able to put off until they can save up and pay for it themselves?
Be alert for signs that your friend has gotten into money trouble that your loan cannot solve. Borrowing money to meet regular expenses is not sustainable unless there is a repayment plan. Alternatively, perhaps your friend has a new job starting in a month and needs funds to get by until then.
Be sure your intention to lend money to a friend does not turn into give money to a friend.
3. Why have they asked you?
This is about the nature of your relationship with the person. How well do you know this friend?
If they are a close friend, they may naturally ask you. However, if the friend is more of an acquaintance, it might be a sign of trouble that they came to you with the request. Perhaps they have borrowed from their close friends already, and now they have moved into a broader circle to find a new source.
4. Can you take time to think about it?
It would be best if you did not make financial decisions in haste. The answer to this question may give you essential information about your friend’s financial situation.
If they need the money immediately, it can signify that something bad is going on. What have they done that requires a large sum of money urgently? Could it be gambling debts or maybe even worse?
Even if the reason is more mundane, a desperate need for money in a hurry may indicate that your friend has serious financial troubles that require more than a chunk of cash from you to solve.
5. Has your friend applied to a lender?
This is a crucial question. Why is your friend imposing on you instead of going to a company that’s in the business of making loans?
Have they been turned down for a loan or have reason to believe they wouldn’t qualify? In that case, you have to question why you should take a risk on a person that professional lenders turn away.
6. Does your friend need credit counseling?
If you have got this far and the answers to questions are not positive, your friend may have serious financial problems.
In that case, a loan is a short-term fix that probably cannot solve those problems. A more lasting solution might be for your friend to get help from a qualified credit counselor.
Credit counseling helps a person determine how to make existing debts more manageable and develop financial habits that wean them off their dependence on debt in the future.
7. What is the plan for paying back the loan?
This is a simple question but one that borrowers often neglect to ask themselves.
If there is no repayment plan, there’s a good chance you may not get your money back. Your friend is getting deeper into debt, and their ability to repay is decreasing.
Assuming your friend is having trouble making ends meet now, how will things be different when the money you lend them runs out? If they need the loan for a one-time expense, have they figured out how much they can afford to pay you back every month?
Your friend needs to demonstrate a plan for repaying the money. That way, you know what to expect, and conflict over an unpaid debt is minimized.
8. Should you charge interest when you lend money to a friend?
As both a convenience and a courtesy, you might not bother with interest if it’s a very short-term loan. However, if it’s going to take more than a couple of months to pay back, charging interest is something you should consider.
During the period of the loan, you lose the opportunity to use or invest that money for yourself. There is a dollar value associated with that lost opportunity.
In particular, during today’s inflationary times, there’s a cost to not having access to your money for a while. Charging interest is a fair way to compensate for that cost.
9. Do you need to put anything in writing?
Depending on the sum involved, this may seem overly formal or awkward for an arrangement between friends. But keep in mind that misunderstandings over verbal financial deals often turn bitter. Putting things in writing might help avoid future conflicts.
Any agreement should include the amount of money, any interest on the loan, and a repayment schedule. You may also like to talk to a tax expert about the potential tax liabilities that can come from lending money.
None of this means that you should not lend money to a friend. You do not need to be cold-hearted to a friend in financial need. However, if they are ready to risk your friendship by asking for a loan, you should be prepared to ask a few questions before making a decision.
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Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.
The Credit Sesame Personal Finance and Credit Survey 2022 was designed and executed by Credit Sesame using the Momentive Inc. survey tool. General population data was collected online May 20-21, 2022. The survey sample comprised 1,222 U.S. residents aged 18 to 99 years balanced for age and gender using U.S. Census data. The sample data is accurate to within + 2.88 percentage points using a 95% confidence level.