If you've ever felt like you were running the Bank of Mom and Dad, then this column is for you.
Lending money to family members or friends is a popular way to share your resources with those you care about, but it takes you down a path fraught with peril. An unpaid loan can ruin a treasured relationship.
The first rule of lending to those you love is to start out grounded in reality, recognizing that your loan may not be paid back no matter how many promises the person has made. Private loans between individuals have a 14 percent default rate, according to Circle Lending, a Boston loan administrator. Loans to help start a new business are particularly risky.
The risk means you should never lend money you could not afford to turn into a gift. You should consult with anyone who would be affected, such as your spouse, if the loan is not paid back. You might even consider making a gift in response to a request for a loan, especially if you doubt that the person will make payments as promised.
Any loan should be handled in a businesslike way that makes your expectations clear. You need a written loan agreement outlining the interest rate, payments, penalties for late payment and other terms. A monthly payment plan is better than a promise to repay a lump sum. (Promissory note documents are available on Web sites such as www.lawdepot.com .) Have your document notarized.
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Larger loans involve special considerations, including security if you can get it. When appropriate, a loan might be secured by a mortgage on real estate or a lien on the title of the car.
You might consider using a third party, such as Circle Lending ( www.circle lending.com), to set up the loan and process payments electronically. That's a way to separate the business of the loan from your personal relationship.
If repayment becomes difficult for your borrower, you might agree to restructure the debt or forgive some interest payments. If it turns out you are not going to be paid, you may have an income tax deduction for a non-business bad debt.
However, the IRS considers loans among family members to be gifts until proven otherwise. Handing the loan in a businesslike fashion and making efforts to collect will help you establish your case.
