Time to read : 4 Minutes
Lending money to a friend can put you in a prickly situation, especially if they’re asking for a number with three or more zeros.
On one hand, you might want to be supportive and help them out. But on the other hand, mixing money with friendship can lead to misunderstandings, damaged relationships, and put a strain on your own finances.
This isn’t to say that you should never loan money to a friend, but before you do, consider these six golden rules that can help protect your finances, but also your friendship too.
Run the numbers – can you afford it?
You should only ever lend money if you can afford to do it. No matter what promises are made, and you think you’ll get your money back, the hard truth is, you may not.
If you can’t afford the risk of losing money you loan, the answer is clear – don’t lend it. The decision to say ‘no’ is really the only way to have peace of mind you won’t get stuck in a financial hole. We touch more on saying ‘no’ later.
Set clear expectations upfront
Being transparent is key. You need to have an honest conversation before agreeing to lend the money.
To get the ball rolling, start with questions around their needs and motivation and then follow through with questions addressing the returns you can expect. Here are a few conversation starters.
What’s the money for?
How much do you need?
When do you need the money by?
Is anyone else lending you money, and if so, how much?
When can you start paying me back?
Do you have a plan that shows you can afford to pay me back weekly, fortnightly or monthly?
Think about any other questions you’d like to ask to help make your decision and let your friend know what’s important to you. Don’t be afraid to say you need some time to think and go over your finances.
Get legal advice for large sums
If you’re willing to loan out a really large amount of money – for say a car or even a home deposit, to avoid any issues with repayments, you’ll want to get some legal advice.
A lawyer can work out all the loan terms including any non-negotiables you want included. And by making this agreement legally binding it’s a way to make sure your friend keeps their word. If not, you could take legal action.
Be aware: getting a lawyer to draw up a contract will add extra costs to the loan, and the legal bill will be sent once the paperwork is done. If you’re footing the legal expenses from the onset, but expecting the legal fees to be shared, make sure this is clearly noted.
If lending a large sum is something you’re not comfortable doing, you can still help by encouraging your friend to explore other options and assist them along the way.
Treat it like a business deal
If you aren’t going the legal route you’ll still need to do some admin work on the terms of the loan, so you're both on the same page before the money changes hands.
Sit down together and create a document outlining the terms you agree on and all the expectations. For example, will interest be charged and at what percentage? Make sure you both have copies of this ‘contract’ between friends.
Having everything in writing can help make sure the lines don’t get blurred – which can easily happen with verbal agreements.
Be aware: if there’s an issue with repayment… and you need to go to court, an informal document such as this may help show the money was a loan and not a gift, but would not be as strong as a legally binding document.
At a minimum, make sure the paperwork is signed and dated by both of you and clearly states:
the sum you lent
loan terms
repayment amounts
interest (if being charged).
Accepting that lending money comes with risk
You would hope this never happens but there’s a risk your friend might not be able to repay you on time, or at all. Not only does this hurt financially but it’s likely to have a big impact on you emotionally too.
Friends and money don’t always mix so before you dive in, consider the long term impact on your friendship in case things go pear shaped. And keep in mind, the way you think you’ll feel may actually be different to how you feel, if the situation arises.
Know when to say ‘no’
While it may not be easy to do, know this: it’s okay to say ‘no’.
If lending money will cause you stress, or if you’re unsure your friend will repay you, saying no can sometimes be the best way to protect both your finances and your friendship.
The same applies if your friend asks to change the loan terms after everything’s been agreed. Just because you agreed to lending the money doesn’t mean you have to say ‘yes’ to everything that follows. You should always protect yourself first. So be firm but gentle and don’t feel pressured to give in.
Bottom line
Lending money to a friend isn’t for everyone – and if you do, it can be a delicate balance of trust and caution. By following these golden rules, you can support your friend hopefully without putting your finances – or your relationship – at risk.
Remember, sometimes the best support you can offer is guidance or emotional encouragement, rather than a loan. Being honest and thoughtful upfront can save you a lot of heartache down the road.
Go deeper:
Sexually transmitted debt: could you be liable for your partner’s bad money moves?
What’s the best way to protect Bank of Mum and Dad (BoMaD) finances in case there’s a break-up?
Financial disclaimer
The information contained on this web page is of general nature only and has been prepared without taking into consideration your objectives, needs and financial situation. You should check with a financial professional before making any decisions. Any opinions expressed within an article are those of the author and do not specifically reflect the views of Compare Club Australia Pty Ltd.
