How should I lend money to friends and family?

There are numerous reasons why a friend or family member may approach you for a loan. They may need a substantial amount, perhaps to start a small business or to buy a car, or a smaller amount to get them through a financial crisis such as the loss of a job or a medical emergency.

Borrowing money from you is less onerous than borrowing from a registered lender, such as a bank, and may result in lower costs and interest.

However, because you are friends or relatives, the dynamics shift, and lending money could alter your relationship, particularly if they default on repayments.

Before opening your wallet, make sure that the friend or family member is financially responsible and will pay you back. Otherwise treat it as a gift with no expectations, but bear in mind that gifts above a certain value may be subject to donations tax.

Even if your friend or relative agrees to pay you back, keep in mind that they may not stick to the arrangement which could have a negative impact on your financial security.

Don’t lend your credit

If you don’t have spare cash, you may be tempted to lend your credit or store card to your family member. But remember, you are responsible for this debt, and if they don’t pay you back and you can’t afford the repayments, it could damage your credit score.

You also have no control over how much they spend, particularly if the card has a large credit limit. Giving out your card details may also compromise your security if fraudulent transactions occur on your account.

Make sure you are both on the same page

Before lending money, have an honest discussion with the friend or family member to determine what the money will be used for and how they intend to repay it. If you are lending the money, you must make it clear that it’s a loan and not a gift.

You can assist your friend or relative by drawing up a budget that includes repayments which may be monthly or a lump sum. Discuss the terms, interest rate and payment dates. A loan calculator can assist you in working out an affordable repayment plan.

Also discuss what will happen if they are unable to make the agreed repayments. By addressing this upfront, you eliminate the possibility that late payment or non-payment will be overlooked because it’s a family arrangement. Agree on the consequences of late payment, such as a grace period or a late payment fee.

Interest and tax consequences

You can decide whether or not to charge interest. If you charge interest on the loan, you must register as a credit provider in terms of the National Credit Act (NCA) for the loan agreement to be enforceable. If you don’t charge interest, you don’t need to register as a credit provider.

Interest earned must be declared in your income tax return. The first R23 800 interest earned per year is exempt if you’re under 65 and R34 500 if you’re 65 or older.

Draft a written agreement

Having everything in writing eliminates future misunderstandings. The loan agreement should include:

The lender’s and borrower’s names.

The loan amount.

Whether interest is being charged, and if so, how much and how it will be calculated.

How the loan will be repaid, either as a single amount or as a series of repayments.

If any collateral has been pledged as security for the loan.

The consequences of the borrower not adhering to the agreement, including changing the loan terms, taking ownership of the collateral, or legal action.

Both of you should sign the agreement, and you may also want to have another family member sign as witness. If the loan is large or there are other factors, consider having a loan agreement drafted by a legal professional.

Keep records of repayments

Record each payment and send a statement to the friend or family member reflecting the payment and the outstanding balance.
This shows that you are serious about the loan and treat it as a business arrangement.

Avoid future problems

There is no guarantee that lending money to a friend or family member will be stress-free, but having a frank discussion upfront, agreeing on the terms, and formalising things in writing prevents misunderstanding which might lead to problems later on.
Furthermore, by understanding the legal and tax implications, you can protect yourself at the end of the day.

This article was written by Sylvia Walker with thanks to the Debt Counsellors Association of South Africa and Caveat Legal for their input.