Has a friend or family member ever asked you for a loan? Or have you been tempted to offer money to someone in financial trouble?
Bring on the proverbial can of worms. On one hand you may never see the money or friendship again. On the other you could be making a real difference to someone else's life
During my OE I lent 200 to a friend. I remember being pretty annoyed that I was being asked to lend money for what I considered to be a luxury - going on holiday. Was I right to do it or wrong? I don't know. But the money was quickly paid back.
There are pros and cons to lending money to friends and family. Some of the reasons in favour of lending money are:
• Because you care and you want to help the other person.
• It's a generous thing to do and a way of sharing your good fortune or hard work.
• It may be expected in your family or culture. People who do well need to help others.
• For some people it may be a Christian thing to do.
There are no other options for your friend or family and he or she really needs the money.
There are many reasons not to lend. Some of the key ones are:
• Something can go wrong. Even the most trustworthy person could lose his or her job, fall sick or die, as Liz Koh, financial adviser at Moneymax, points out.
Loans to family and friends tend to be open ended. There isn't a deadline for the money to be repaid. Without a finite period, the loan may slip onto the never never.
Other debts take greater priority. Who would you pay if you could only afford one payment: your family member/friend, or the company that was threatening you with black marks on your credit record and/or a bailiff? You're at the end of the food chain - especially with people who have bad money management skills.
Talking money with friends and family breaks a taboo in our culture. So we fail to ask for the money back or even discuss why payments aren't forthcoming.
Social occasions can be difficult. If the borrower defaults it's going to make family gatherings awkward. Resentment builds up. Friends who owe money may start to avoid you and the friendship breaks down.
If you've lent once you're fair game for more requests. You're a soft touch, after all. You may be viewed as having lots of money that can "solve" the borrower's problems in his or her mind. Ironically you may well be exacerbating those problems by lending in the first place.
• You risk losing your money. It happens. The first few payments come through, a few are missed and finally the borrower hopes you've forgotten about the money or written it off.
• The borrower may use your money for a different purpose than for which it was lent, points out Koh.
• It could be the end of the relationship. "Neither a borrower nor a lender be," Shakespeare wrote. "For loan oft loses both itself and friend." Just Google words such as lend/money/friend and you'll soon come across stories where both the friendship and the money disappeared.
Just because you've been asked, doesn't mean you have to lend. It's a risk on more than a financial level. The chances are that the person needs money because they're not good with it. They don't pay bills on time and they go from one financial crisis to another.
By lending to them you may be perpetuating the problem and giving them a get-out-of-jail-free card for solving the problem.
Trade Me's community forums always come up trumps when I want to see how the public views a particular money issue. And there was plenty of discussion about money lending when I checked.
Member "totalimp" asked just the question I wanted to see answered. He or she was considering offering an interest-free loan to help a new-ish friend out of a sticky financial situation.
It was 6.11am when the question was posed and within 13 minutes "Seaqueen", whom I've quoted before for making sensible financial comments, replied: "Fastest way to end a friendship." Paula13 counselled: "Please don't. Offer him your friendship and an ear to listen to but not money. It never turns out well."
By 6.46am there were thought-provoking comments from "biteme" who said if it was less than one quarter of a week's income then he or she would do it automatically. "Remember to ensure the friend knows that it is the friendship which is being used as collateral."
Biteme went on to ask where the intended recipient's older friends and also family were, which was a good question.
Trade Me member "chakendrick" provided post number 51 at 9.22pm that night. His/her experience, as others also recounted, was that invariably loans led to the end of the friendship. "We lent 'friends' money once and they bought a big-screen TV, new kennels and a video camera before they paid us," wrote chakendrick. "We had to wait for their 'tax return'. Others we have lent money to we have never seen it again or they have asked for more."
If you do decide to lend, some rules are worth following.
Document the loan to make it clear between you what's expected. Beware, however, that informal loans between friends and family may not be enforceable in the courts.
"What a contract needs, apart from 'offer', 'acceptance' and 'consideration', is an 'intention to create legal relations'," says Nic Scampion, commercial litigator at Wilson Harle.
"Intention to create legal relations" means that a contract is enforceable only if the parties intended to contract. "Without it, there is no contract."
In theory a verbal contract between two private individuals could be enforceable. There is no magic in agreements of this type being written down, says Scampion. Having said that, it is more difficult to enforce a verbal contract, and particularly in an arrangement with friends and family. "A verbal contract in that situation may just look too informal for a court," he says.
To be sure of being able to enforce the loan, the best thing to do is get an agreement drawn up by a lawyer, especially if a large sum of money is involved, says Scampion.
Loan agreements such as these are covered by standard principles of contract law. The Credit Contracts and Consumer Finance Act (CCCFA) would - generally - only be relevant if the contract is oppressive.
That aside, set up a formal repayment arrangement. Agree the day that payments will be made and have a written way of recording payments so both parties can track progress. It's best to ask the other person to set up an automatic payment for regular repayments. Anyone can do this and it means you're more likely to be paid regularly.
Interest, however little, should always be charged. That means there are consequences if the loan repayments are not made on time. The interest paid escalates.
It's also possible to ask for collateral. If someone really needs the money there might be something of value they own that could be deposited with you as a guarantee. I can't see myself doing this, but it's not a bad idea. Commercial lenders take collateral.
Make sure you are businesslike in all loan dealings. Don't ignore it. Put payment dates in your calendar and arrange to meet for cash repayments or check your account that the payments are through.
Going guarantor on loans or advancing money for a house purchase are another matter and are often a bad idea. You can see what I've written on this subject recently at tinyurl.com/houseguarantor.
My final word is if you know an elderly relative has lent money or is being asked to lend money, look into the details. Elder abuse is often swept under the carpet.