You wanted to help, and even though you had that slight feeling in the pit of your stomach that this could go bad, you did it anyway.
Whether you lent your friend money for an investment or to crush debt, until they pay you back there could be frustration or awkwardness that is hard to escape.
Not only are you out the investment, but you’re also likely to lose a friend if it all goes south and you may not get the money back. Before you lend money, you may want to ask yourself these 15 questions.
Will I be financially okay if I don’t receive these funds back?
You may expect your friend to repay you (and hopefully they do), but ultimately, you should protect yourself by knowing what would happen to you financially if you didn’t get that money back.
Would it mean your bills wouldn’t be paid? If so, don’t do it. You shouldn’t even consider lending money to anyone if you would be in a financial hole when it isn’t paid back.
What is the money for?
You may not initially want to dive into their personal needs, but the reality is that this is an important question. Is lending them money worth what they actually plan to spend it on?
You have the right to know if it’s a worthy cause. If they are brave enough to ask for financial help, you can assume they know you’re going to want to know why.
What is their financial reputation?
Even if they’ve never borrowed from you in the past, this is an important question to understand since you are the one taking the risk.
If they are someone that’s often late on the payments, has collection agencies calling often, or is known in your friend group for being the guy that never pays, those are signs your money may never be returned.
Why did your friend ask you personally for this loan?
Do you have a reputation for lending money to people that they may know, and therefore they think it’s easy for you to lend?
A close friend asking is much different than someone you barely speak to suddenly speed-dialing you. If you don’t know them well and other factors don’t check out, that’s a warning not to make the investment.
Have they borrowed from your friends recently?
Some people need to borrow money every now and then. That’s not that big of a problem. Others constantly borrow, often moving from one person to the next.
While it’s not ideal to ask your other friends about lending, pay attention to any reputation this person has with borrowing. That could be a sign they won’t have the funds to repay you.
Is the IRS going to suspect that this is a gift rather than a loan you’re making?
If you’re lending a substantial amount of money ($17,000 or more in 2023), you may have to file a gift tax return with the IRS. For most people, we'll never give away enough money in our lifetime to actually have to pay a gift tax. But if you're concerned, you should talk to your accountant about it to see if this applies to your situation.
Have they received a denial from a bank?
Ask this question for honest insight. If your friend needs a substantial amount of money, find out if they’ve talked to a bank.
If not, why not? If so, what did the bank tell them? You have the right to this insight because a bank is going to be better positioned to judge the financial creditworthiness of the party than you are.
What other debts do they have?
You don’t need to pull a credit report here, but you do need to dive into what’s going on with them financially. Ask them if they have a lot of debt from credit cards or other sources.
That could mean they’ve maxed out all of their accounts and, without a doubt, are struggling to manage their money.
They may need help with a service like credit counseling or a financial advisor for more significant financial support.
How will the friend repay the loan?
Avoid situations where you say, “Just pay me back when you can.” If this is a substantial amount of money and you’re worried about the financial savvy of this friend, you need a structured repayment process.
Start with a repayment schedule they think they can do easily. Write it down, and both parties should sign the document. That way, it’s clear what is owed and when it’s due.
Do they plan to pay interest to you?
Lending to a friend may mean, to you, just giving them the money they need without a cost to them.
Sometimes that’s fine, but when there’s the risk of nonpayment, or you don’t want this to keep happening, you probably need to charge a fee.
Interest is the easiest option because it encourages them to repay the debt on time, but a simple, fixed fee can also work.
Do they have a history of helping you?
Perhaps you’ve never borrowed money from them. Yet, they have helped you in other significant ways.
In this situation, with no other warning signs of trouble, you might feel obligated. It may have taken a lot of courage to ask, and they may simply need a bit of help in a difficult situation.
Lending to a friend in real need when it’s not common for them to ask could be worth it if you can afford it.
Are they willing to create a formal agreement?
Given the risk of nonpayment, a formal, legally binding agreement could be one way you encourage repayment of the funds.
If you’re lending a large amount of money, have an attorney write up a formal lending document that outlines every detail, including how much is being lent, the cost, the timeline, and the consequences of non-payment.
Do they really need extensive financial help?
Borrowing money constantly could be a sign of significant financial turmoil. They may be stuck in a payday loan cycle with no way out, for example.
Some people may find themselves unable to meet their financial obligations due to a loss of work. They could be battling a mental health disorder like gambling or excessive spending.
Recognize what’s really happening and then, if they are a good friend, reach out to provide them with help for those underlying concerns.
How much is saying no going to impact your relationship?
If you can’t afford it or any of the above warning signs exist, say no. It’s that simple. Make the decision based on the data you have, not on emotions.
If saying no is going to hurt your relationship significantly, then you may need to examine why that is.
A good friend isn’t going to want you to put yourself in a bad financial situation to help them. Often, just saying no and moving on is a fast and simple solution.
Will saying yes make a true difference in their life?
What if you can afford it and you want to genuinely help them? Saying yes could be an option for you as long as you head into this situation, recognizing that you may not be repaid.
This may also be a good time to offer other help, like help to improve their resume, going to a credit counselor with them, or giving them tips that work for you.
Don’t be cold-hearted to a friend who genuinely needs a bit of help right now. If you can afford it, consider it a gift instead of a loan, especially if it helps them to do better financially, pay for valuable medical treatment, or avoid foreclosure.
The key here is to do what is financially safe for you while helping someone who is genuinely in need but not someone that’s dishonest or simply unable to repay you.
But, you should never feel bad about saying no if you can’t afford to lend the money. You going into financial trouble for them isn’t really helping anyone.