Loans to friends or family members
can often become a sticky business.
Number one rule: Use the same care-
or more-in lending money to a friend
as you would in lending money to an
institution.
When a friend or family member
approaches you about a loan, inform
him that this is a business deal and will
be evaluated as such. By taking this ap-
proach you help remove some of the
emotional strain involved for both of
you. In the long run, you will also
reduce the risk of losing your money.
Analyze the situation as a banker
would: How good is your friend's
credit? How will your friend use the
money? How and when will your friend
repay the loan?
Examine Alternatives
Always check to see that your friend
or relative has examined the alterna-
tive sources for a loan. The most obvi-
ous include:
Banks.
Second mortgage on house.
Loan on whole life insurance policy.
Company pension, profit-sharing, or
savings plan.
Brokerage account.
Small Business Administration, if the
loan is for a new or existing business.
Trade credit, if the loan is for a new
or existing business.
The advantage of this exercise is that
it casts you in the role of financial
adviser, notjust friend or relative. More
importantly, you may help the other
person pinpoint a source of funds he
overlooked.
Put it in writing:
Whether a loan is to a friend or a
member of your family, any agreement
should be in writing. Forms of promis-
sory notes (also known as IOUs),
which are often available in stationery
stores, can be used for this purpose.
What should be included in the agree-
ment? At a minimum, it should specify
the amount of the loan, its terms, and
the interest rate, if any.
You may want the interest on the
loan to compensate you for the income
forgone as a result of making the loan.
For example, on a one-year loan, con-
sider charging the going rate on one-
year certificates of deposit.
Try to eliminate possibilities for
future misunderstandings. If you can,
address the following questions in your
agreement: Will the loan be amor-
tized? Will payment of principal and
interest be made monthly or quarterly,
or will only interest be payable at fixed
intervals, with a balloon payment
specified at the end? Will the loan have
a fixed term, or be payable to you "on
demand"?
The following is an example of a
simple promissory note that covers
these questions:
$5,000 Dated:
Promissory Note
FOR VALUE RECEIVED, I_______
("Borrower") promise to pay to the
order of the sum of Five
Thousand dollars ($5,000.00), payable
commencing on , 19 , and
each succeeding month thereafter for
months in equal monthly install-
ments of principal and~% interest in
the amount of____dollars ($
(Borrower)
The signature of the borrower is es-
sential to making the promissory note
legally enforceable. The main purpose
of a written agreement is not to
frighten your friend or relative into
thinking you'll haul him off to court,
but to emphasize that borrowing
money is a serious business.
Source: Karen r. Stein, Ph.D., associate professor of consumer
economics at the University of Delaware, Newark, DE 19716.
Author of numerous publications on consumer affairs, she is
former executive director of the American Council on
Consumer Interests.
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