I have seen many examples where these lending arrangements have caused considerable grief and anxiety for the lender. What starts out as a helpful deed based on love, trust and promises can lead to bad feelings, arguments, loss and relationship breakdowns. There are some simple principles that you can use to protect yourself and preserve your relationship with the other person.

Any arrangement involving the lending of significant amounts of money should be treated as a proper business transaction rather than being done on a handshake and a promise. That means there should be a clear agreement on what the terms of the loan are - the amount, whether any interest is payable, the frequency and amount of repayments, and the time frame for repayment in full. This should be recorded in a written, signed agreement especially if the amount is large, so as to avoid the potential for the loan to be deemed a gift and therefore subject to gift duty. If either the lender or the borrower dies, a written agreement is clear evidence of the existence of the loan that can be taken into account by the executor of the estate. It's a good idea to insist in the agreement that the borrower sets up a regular automatic payment to you. This is no guarantee however, as the payments will not proceed if the borrower has insufficient funds in their account and the borrower can cancel the payments at any time.

Before you proceed with drafting up an agreement there are some questions you need to ask the borrower. The first and most obvious question is what the money is intended to be used for. If it is to be used to pay off gambling debts or for an overseas trip you might want to think again.  Record the purpose of the loan in your agreement and follow through to see that the money has in fact been used for that purpose, for example to buy a car or pay off a large credit card debt. One way of doing this is to pay the amount directly to the third party involved rather than to the borrower. If the money is to be used to help set up a business, be aware you are faced with even more risk because the business may prove to be unsuccessful. Unless you have the skills to evaluate a business proposal you should either pay an independent expert to evaluate it for you or refuse to lend the money. The second question to ask is why the borrower is unable to borrow money from a bank or finance company. If they have been refused because they are already overcommitted or they have a bad credit history then chances are that you will have problems getting your money back. Try and establish how responsible this person is with money. If they have a track record of constantly getting into debt through irresponsible behaviour and then expecting to be bailed out, there is a high chance that if you help them to clear their debts they will eventually end up back in the same situation again unless strict budget controls are put in place.

Don't ever lend money that you can't afford to lose. If you are dependent on the borrower making repayments so that you will still have enough money to live on yourself or for your retirement, then you are taking on too much risk. There is a high default rate on loans to family and friends so be prepared for the worst, and remember there is good reason for the old adage 'neither a borrower nor a lender be'.

Article by Liz Koh

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