How to lend money to family or friends without losing either8-January-2016 Commercial Disputes By Evatt Styles
The old saying, “Neither a borrower, nor a lender be – for often you lose both the money and the friend”, is commonly very true for borrowers and lenders today.
Loans to friends and relatives can be particularly fraught due to varying expectations by both parties.
Streeterlaw Senior Solicitor Mr Evatt Styles said it is important that the terms of any loan are clear. “Loans to friends and loved ones are often the hardest to recover. Their terms are expected to be flexible and calling in the loan through default is a difficult decision to make for lenders, who grapple with the tensions that it will cause to the relationship,” he said. “The key is transparency and security.”
A common lending scenario and dilemma
Married couple Jane and Tom own their own home in Sydney. Fred, who is Jane’s brother and Tom’s brother-in-law, is a businessman who lives in Sydney as well and has approached Jane to borrow money to put towards a property development.
Fred promises Jane fantastic returns, saying “You are family! I will even give you some of my returns from the rental yield. The property is going to make a killing. I just need $50,000 as a deposit. This development is a sure thing.”
Jane approaches Tom, who reluctantly agrees to provide the money. Months later, Jane tries to contact Fred without luck. News at family events is that Fred has moved overseas. Tom eventually manages to contact Fred who says the invested money is coming.
Since Jane and Tom had no agreement in place with Fred, there is little they can do to force Fred to repay the money borrowed. The problem for Jane and Tom arose because they lent money on a loose verbal agreement (a common mistake), with no clear agreement on when the money was to be repaid and what security was in place to ensure that the loan would be repaid.
Useful tips to successfully lend money to family and friends without losing either
The circumstances of the loan
As a lender, it is important that you ask questions of the borrower such as:
- What are you going to use the money for?
- When will you be able to pay it back?
- How much are you going to be able to pay back per month?
Do not be afraid to ask the borrower questions about their employment, salary, assets and liabilities and use these answers to start considering the terms of the loan agreement.
Any loan should include a payment schedule and date for final payment. This is the only way you can ensure that repayment of your money becomes their priority and a part of their day-to-day service of the loan.
Does the borrower currently have a home or car? If they do, you may be able to obtain a secured interest in that car or home.
With homes, security can take the form of a mortgage or in the case of personal assets such as cars, boats and motorbikes, it will take the form of a Personal Property Securities Act security interest. In either case, the asset cannot be sold without the security interest being discharged. In the event of a default of a term of your loan agreement, it may allow you to sell such an asset.
If you do not have security for a loan, then you can expect to be recovering such money as an Unsecured Creditor.
The loan agreement
Your ability to recover any loan will be based on the quality of the documentation that articulates the terms, the security and default provisions of such an agreement.
Legal costs and interest
The majority of family/friend loan agreements neglect to include default interest and an indemnity for the legal cost and disbursements of the lender in their attempt to recover the loan amount from the borrower.
This omission means that lenders of small loans are not only sacrificing their money, but interest. In the event that you need to recover the loan, it is vital that you are able to recover your legal professional fees and disbursements.
In summary, these tips could save pain and heartache for lenders:
- Obtain advice and draft a Loan Agreement before lending.
- Ask the borrower what they are using the money for and when/how they are going to pay it back.
- Do not feel guilty for including default terms, interest and legal fees.
- Avoid becoming an unsecured creditor.
- Obtain advice on recovering any loan as soon as you feel something it is not right. Your failure to act quickly may adversely affect your ability to recover your money.