If your relative or friend asks you for a personal loan, what is your reaction? What is the immediate thing that comes to your mind? Are you going to loan them money? Here are five useful tips if you find yourself in this situation.
Being asked to give a personal loan by relatives or friends will put you in an awkward situation. It resembles being thrown into an open space filled with explosives! You will not give an immediate answer and your inquisitive mind comes into play.
Knowing someone facing financial distress is not surprising in the present economic situation. Money is hard to come by. Every day you heard news of people losing their job and businesses closed down.
A sympathetic person like yourself may want to give a helping hand to the unfortunate. But you are cautious and reluctant to part with your hard-earned money which you may need later. Stories about borrowers not paying back loans are the norm. People often take family ties or friendship for granted when money is involved. It’s hard to decide with these hesitations in your mind. Further, it is more difficult when the amount requested is considered large by the lender standard.
To guide you, there are five key areas to consider before you break open your bank.
1. Will You Have Regrets?
Only agree to give the loan when you really want to. It’s best to turn down the loan request if:-
- You have hesitations, or
- Giving out the loan is making you feel guilty (the asker is begging for help)
You will feel bitter and resentful later on if you forced yourself to give the loan. This can harm the relationship with the borrower. Refusing to the request would not make you a bad or selfish person. But it’s not easy turning down a family or friend request.
Still, being truthful in your thoughts actually help to keep the ties and friendship.
Rather than only turning down the request, give some alternative solutions. An understanding relative or friend will ultimately appreciate and thank you for the suggestions. On the other hand, the asker may respond with unkind words. If that happens, keep your cool. You need to think twice whether it is worthwhile to continue with the relationship. It’s better to find out the true character before any money changes hands.
2. Accept Possibility of Bad Debts
Accept the possibility of the loan becoming bad debt and not losing sleep over it. In other words, the loan amount to give is should be a figure you can afford to lose. It won’t cause you hardship or change your current lifestyle.
The borrower may have passed all the criteria of a character that would reliably return the loan in full. But, there is always the possibility of the opposite happening. You can’t predict future events. The borrower may have gone on to get a further loan from an illegal lender. Illegal money lenders may not be professional in dealing with defaulter. If that happens, the borrower’s new priority of repayment is to them and repaying you is pushed to the bottom of their priorities.
Imagine the stress, tension and anger if the borrower can’t repay and you need the money now. In hindsight, you might have to turn down the request or reduce the loan amount.
3. Fix a Repayment Schedule
Have a mutually agreed upon, well thought-out, and realistic repayment schedule. This should be a fixed monthly instalment and not “pay-as-and-when-convenient”.
There must be mutual agreement on the expectation and affordability of repayment. This will prevent dispute or avoid “I-thought-we-are-thinking-on-the-same-page” mistake. This will also confirm that it is not a gift but a loan that need to be repaid.
Setting the repayment terms may seem business-like. But it will be good for both parties to avoid miscommunication. It set out the expectations and responsibilities. Examples are repayment amount, date, period, reminders, and interest (if any).
4. Get Commitment in Writing
The personal loan given must put in writing. This is to avoid confusion or disagreement on the terms agreed earlier. Otherwise, the conflict may strain the relationship.
A loan document (handwritten or electronic) will make sure commitment from the borrower. There should not be any doubt after execution of the loan document. Any dispute or misunderstanding resolved by referring to the loan document.
A simple promissory note will suffice without hiring the services of a solicitor. It should contain the following information:-
- Details of the lender and borrower. Such as name, identification number, address and signatures;
- Agreement dated;
- Loan amount and period, fixed repayment amount and date, interest (if any);
- Collateral (if any); and
- Witness (optional but recommended)
Download Simple Promissory Note template (MyPF Premier)
5. Be Strict in Collecting
Don’t let late payments pass without sending reminders (calls / reminder letters).
Strict compliance with the terms of the promissory note is a must. The lender must take immediate action for any non-compliance especially payment due date. Otherwise, the borrower will take it for granted and forms a late-payment habit. Without any action from the lender, the borrower will treat the loan agreement as only a guide and not as the rule.
The lender must treat this as a commercial transaction and the borrower as a client. Send the necessary reminder letters and phone calls. If it’s not too inconvenient, pay a visit. If all else failed to elicit a response, the last resort is taking legal action.
Have you ever given a personal loan to family/friends?
He has 25 years working experience in different finance-related jobs. He is now a consultant, and personal finance and business writer. His main goal is to help and educate non-finance professionals to understand and solve their personal finances problems. He believes everyone should be financially literate because everything we do has money implications!
Eric currently resides in Kuala Lumpur, Malaysia with his wife and two young children.