Money and Friends: How to Lend to a Friend

If a friend of yours came to you and asked for a loan, would you go on to give them your money?

"That is a tricky affair. But it depends on whether the sum borrowed is small enough to not devastate me in case they do not pay it back," says Brian Omondi, a Student at UON.

On the other hand, Joy Akinyi, a resident in Eldoret, would lend to very close family members unconditionally but is a little untrusting of her friends.

"For my parents it is unconditional. But I do not think I would give my friend a very large sum. What if something happens and I don't get back my money?"

In a survey done in 2009 by CNN Money, about 27% of people who offered loans to friends or family didn't get their money back at all, and 43% did not get their money back in full. This is to say that money lent between family and friends seldom works, and relationships get destroyed most of the time.

Opinions differ from person to person. Some will go ahead to empathize and have faith that they would recover their money, but most fear destroying relationships on top of going on a loss, and for this, they refrain from lending to friends.

Choosing to lend money to friends opens relationships to the risk of getting jeopardized. But how easy is it to say "no" to a friend who needs your help out of a bind?

Navigating through this is a challenge both financially and personally. Before lending money to anyone you consider close, take measures to minimize financial risks and avoid unsalvageable damage to your relationship.

Here are some tips to consider before lending out to a friend.

1. Don’t Agree to It on the Spot

When a friend comes asking for a loan, take your time to think about it. Don't be carried away at the moment and say "yes".

Instead, employ a delay tactic. For example, you might say

"I will have to check my finances to see if it's possible right now. While I do this, perhaps you could check out some creditors like a Sacco or Credit apps."

With any luck, they may find a solution with a different lender.

Read Also: Money and Me: Ups and Downs of Lending to my Family Members

2. Don’t Be Afraid to Say “No.” 

Sometimes, you may not have the money to loan, or you might not want to give out your money. Whatever your reason is, just say "no".

However, if your friend's incapability to pay you back is the reason for you to lend to them, then you might want to find a different reason to tell them to keep your friendship.

For instance, you could say, "I have a rule that does not allow me to lend money to friends because it may mess up a friendship."

If they try to put you on the spot, play the delay tactic we had mentioned earlier. You could later send a text saying you cannot afford the loan.

3. Create a Contract

If you are lending a large sum of money ("large" is relative to how deep your pocket goes), it's vital that you draft a document that will lay out the terms of the loan. The document should lay out who the lender is, how much and to whom the money is being lent, dates when the borrower is supposed to start payments, and the total duration of repayment. If there is some interest to be paid, then let that also be stipulated. This document will act to protect you from any misunderstandings, and in case the borrower refuses to pay you back.

Remember to have the borrower sign the document; otherwise, it will not hold water as much as it should.

4. Only Lend What You Can Afford to Lose

Any pro gambler will tell you for free that you should never bet more than what you can afford to lose. The same applies to lending to friends.

After assessing your finances, you could find you can't afford it. You might be having financial challenges. You are not obligated to act as a bank for your friends.

If a small loan cannot break you, then you should prepare psychologically for the possibility that you might never see the money again. Consider the loan as a gift. That way, you are giving them the allowance to default.

Don't give a loan that you are not able to forgive both financially and emotionally, in case your friend defaults.

5.  Consider Taking Collateral

Not every borrower owns an asset of real value, such as a car or expensive jewellery. But if they do, ensure you take some collateral. Taking collateral reasserts the message that the lender-borrower relationship you have is different and not as cordial as your personal relationship is. It should be clear that you are not operating as a charity, and there can be consequences if they fail.

6. Charge Interest

You can charge some interest just to keep the relationship professional.

That could mean a small interest rate to keep up with the inflation level. It could also mean minimizing your opportunity cost since your money could have been used on invested for greater returns.

Your friend put you in that position, so they shouldn't complain when you impose on them some interest.

7. Do Not Micromanage but Still, Give Them a Call to See What’s Going On

If you have known your friend for a long time, and you trust them completely, then it is alright to give them some room.

However, remember that it is your money, and you are entitled to it. Do not be afraid to call them up to find out what went wrong in case of a defaulted payment.

If the borrower doesn't seem apologetic or concerned about defaulting or late payments, then you would be justified to not be flexible.

8. Know When to Say No to Loved Ones

If you aren't certain if you can afford to give out money to your friends, then just say no. it wouldn't be the best idea to dive into your emergency fund just because your friend is in financial turmoil.

Especially say no when you see flags in your friend's character. For example, if they like to gamble, if they are drug addicts, or are "natural" defaulters.

WRAPPING UP

So is lending money to your friends the wisest financial decision? Maybe not. If you absolutely must lend a friend, ensure you make decisions with your head, not with your heart. Prepare for the worst, and try to maintain your new lender-borrower relationship separate from your personal relationship.

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