People often turn to friends and family for help when they have a cash flow problem. Out of those who have had this kind of arrangement, 37% said that they lost money, whereas 21% said that it ruined their relationship. It is important to have a plan to prevent this kind of problem if you borrow money from friends or family. Take a look at the potential problems that you should avoid when you do this kind of transaction.
- Make Sure You Have Documentation
One of the biggest problems with loans between friends and family is that they don’t draw up a contract. They often have an agreement verbally, which can lead to misunderstandings. The best way to avoid this problem is by drawing up a contract that outlines the terms of the loan.
- Use Collateral
Collateral is required by some lenders because it reduces their risk when they make a loan. However, it needs to be written into the contract. People often don’t write it out because of their personal relationship, and the lender trusts the buyer. However, without a written contract, the lender may not ever see the collateral if the loan defaults.
- Protect the Loan From Taxes
If a family member or friend gives someone a loan without documentation, it can be taxable. The only way to avoid this is by making sure that there are documents that include the payback terms, including the interest rate and proof of repayment. This way, the lender won’t be subjected to a gift tax.
- Consider the Potential Consequences
A loan between family members or friends can end in the loss of a relationship, so it is important to consider how to prevent it. First, as the lender, what will happen if you aren’t repaid? It is important to make sure that you can handle this potential consequence. As the borrower, you need to consider your options if the business isn’t successful.
- It Can Increase Debt
Sometimes a personal loan serves to do little more than increase debt. They may not be able to afford the loan, which is problematic. It is important for the lender to consider whether or not the loan will yield positive results.