Five rules to follow when lending to a friend or a family member so that your money and the relationship both stay safe.
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Updated: 15 Feb 2022 8:19 am
In the year 2011, 60-year-old Neeraj Patel (name changed) lent around Rs 20 lakh to a close friend who was in financial distress and needed money to start his own business. His friend had a good reputation so Patel didn’t hesitate to lend out his lifetime’s savings without any formal paperwork. However, in the years that followed, Patel’s friend paid him back twice the equated monthly instalment (EMI) for two consecutive months but stopped after that. Things took a turn for the worse when Patel’s friend passed away a few years later.
Almost a year later, after recovering from the shock of losing a dear friend, when Patel and his family approached his friend’s son, who was working at a reputed MNC, for the money, they did not get any response. Patel soon realized that this savings had turned into a bad loan.
“The son initially agreed to meet me but then didn’t turn up for the meeting. After that, he even stopped taking my calls,” rues Patel.
You are clearly being a ‘good Samaritan,’ when you are lending money to your friends or family in times of their need. But your ‘gesture of goodwill’ will go to waste, if your effort results in a misunderstanding or financial loss.
Here are five do’s and don’ts you should follow when lending money to friends or family:
Do Ask Yourself If You Can Afford It
You must first reflect on your own financial situation when a friend or family asks for money. If lending money to someone puts a strain on your finances, or if you have to sacrifice a lot to manage your expenses after that, you should avoid doing it then. However, if you have enough savings or a big enough emergency fund, and little or no debt, you could perhaps help out a friend.
Do Charge Interest And Use Collateral
“Money can be thicker than blood, and it can ruin relationships. So, for the sake of the relationship, it’s better to keep things on point from the very beginning. We should keep a control on our emotions as friends and family may take things casually. To avoid this, it’s better to have a fixed rate of interest and some collateral security against the loan amount,” says Hemant Beniwal, director, Ark Primary Advisors, a financial planning firm.
Do Have A Written Agreement
This is a difficult, even awkward, thing to do, but a written agreement will help avoid any misunderstandings and will clarify the responsibilities for both the parties. The agreement gives you grounds for legal recourse in the unfortunate event of you needing to sue them later to get your money back.
Don’t Get Led By Emotions
If you feel your friend or family is in genuine need, you could lend the money. But also consider the borrower’s ability to repay. If they are working, find out how much they earn and what their other financial commitments are. Also try to find out whether the borrower is responsible about finances.
“Often, people lend based on emotions and do not actually treat those loans as a serious debt outstanding. They tend to take these loans casually as there is no interest liability and is unlikely to lead to any legal complications,” says Beniwal.
Don’t Feel Obligated In Money Matters
Ideally, you should not lend money simply out of a sense of obligation. If the loan doesn’t make sense to you financially, don’t go ahead with it. Also, when we are aware of a person’s liabilities, or know that he or she has a bad credit history, we must accept that the borrower will most likely be unable to repay. In that case, it’s best to avoid lending at all. “Also, as a lender, you have a right to know what the money will be used for. If the reason seems illogical to you or you feel the person is taking the loan to simply fulfil his or her aspirations for luxury, you should steer clear of such transactions,” adds Beniwal.
While the decision to give the loan is entirely yours, following the above-mentioned do’s and don’ts will protect your money and your relationship with the friend or family member, which can be very precious.
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