In times of need, a family member may consider borrowing money from if they want to avoid the lengthy approval process from banks and require money urgently.

This is a much-preferred option for several people, especially in India, as most people do not have the necessary documents to be eligible for getting loan approvals from banks. Naturally, they turn to family and friends.

However, you need to be careful of certain things when you consider lending money to a family member or a friend.

Things To Consider While Lending Money To Family Or Friends

  1. Are they confusing it for a gift?
  2. Is there any other way to help out your family member financially?
  3. Is there any way to secure the loan transaction?
  4. Make sure you are aware of all the legalities
  5. Loan to family member tax implications
  6. Can you loan money to a family member tax-free?
  7. Make use of online channels
  8. How much interest should I charge a friend?
  9. Say no if necessary
  10. Should you draw up a contract?

Keep in mind the following points and questions to ensure that the entire experience doesn’t turn into a misunderstanding and doesn’t hurt your finances:  

  • Are they confusing it for a gift?

Sometimes, due to the close relationship, friends or family members may treat the entire process of borrowing money from you very casually. They might be under the impression that the amount is a gift from you and there is no need to repay.

Thus, it is always essential that you put across the point in clear words that you would need the money back and also mention the time frame within which you would need it back. Bottom-line, make sure you clarify that the loan is not a gift. 

  • Is there any other way to help out your family member financially?

It is considered a good idea to not lend money to a family member or friend as it may sour the relationship later on. If you do not want to lend money, find out if there are other ways in which you can financially help your family member out. You may consider co-signing a loan agreement so that the family member’s loan request gets approved.

However, a risk involved when you co-sign a loan agreement is that if the borrower fails to return the borrowed amount, your credit score will be impacted too.

In other words, if you aren’t able to lend them the money, try to help them by helping in procuring funds from other sources. There are also several lenders, like PaySense, that offer unsecured personal loans with no collateral or securities. You can get instant personal loans up to Rs. 5,00,000 from PaySense at affordable interest rates and flexible EMIs. 

  • Is there any way to secure the loan transaction?

As discussed above, there may be many scenarios wherein the borrower may fail to return the amount you lent, despite their best intentions.

For instance, they might start a business which may never turn profitable. Thus, to ensure maximum financial protection, make use of collateral to secure the transaction.

This would mean that you can gain the possession of any asset of the borrower, much like a bank, and use it to cut your losses in case you aren’t paid back. While this might seem harsh, it can be very beneficial during the worst-case scenarios.

Especially when you lend the amount for a large purchase, like a home, it is always better to insist on securing the loan through collateral.

  • Make sure you are aware of all the legalities

If the amount in question is substantial, make sure you are aware of the legalities of the transaction. The best way to get a clear picture of how to make the transaction a secure one is by approaching a legal attorney. Before lending the amount, consult a licensed attorney and experts about the risks involved.

This is particularly true if your family member or friend is investing in another venture, starting their business or using the money for commercial purposes. After this, if the transaction seems secure to you, you can go ahead and lend the required amount.

  • Loan to family member tax implications

Make sure you are aware of all the tax implications related to lending loans to family members are friends. Remember, for family members, there are no tax implications of gifts and loans of any kind or amount.

However, any non-relative, or friend, can give you a gift of up to Rs. 50,000 only and gifts above that are taxable. But, if you provide friends with a loan of any amount (interest-free or with interest), it becomes tax-free. If you are charging your friend or family member interest on the loan, no matter how nominal, it will be considered as a part of taxable income, as income from other sources. 

  • Can you loan money to a family member tax-free?

Before 1997, when the Gift tax was applicable and a person lending his income to his acquaintances was taxed. Currently, there are no taxes on individuals who loan money to family or friends, regardless of whether they charge interest or not.

Similarly, the Gift Tax now permits the transfer of amounts as gifts up to Rs. 50, 000, without any taxes. Loans, which are not gifts, and are to be paid back by the borrower, are not taxed either. 

  • Make use of online channels

To ensure that there is a proper record of the transaction, make sure you lend the money using online banking, cheque or demand draft and avoid lending money in cash. This gives the entire exercise an official transactional record, which can be useful in case of future conflict. If your friend or family member insists on instant cash loans, pay only a small part of the loan as cash and transfer the rest of the amount using online payment channels. 

  • How much interest should I charge a friend?

As mentioned earlier, loans by family and friends are tax-free for the lender and borrower; thus, the decision to charge interest is entirely your call. It is important to note that if you decide to charge your friend an interest on the loan amount, the same will be counted as your taxable income.

Remember, most people turn to family and friends because it’s easier and quicker to get a loan from them, and they usually charge rates that are lower than the ones prevalent in the market.

Thus, depending on the loan amount, the tenure and the conditions, you may decide on a rate that is acceptable to you and your friend. Make sure you mention the rate of interest in the contract or agreement drawn. 

  • Say no if necessary

If you do not have the required funds yourself or are hesitant to lend your family member or friend money, make sure you communicate the same to them. You don’t have to outright reject their request and cut ties, but gently turn them down. Explain your reasons and help them by supporting them in finding alternative sources of funding. 

  • Should you draw up a contract?

If you want to make things formal, it is best you draw up a legal document to make an official record of the loan. You can go for a promissory note, which is a promise by the borrower to repay the loan amount by a fixed date; or a loan agreement, which can be modified at a later stage.

You can include any conditions that are mutually-acceptable, like rate of interest, payment in installments or as a lump sum, payable on demand, etc. in the agreement. Make sure to get the agreement notified by the borrower and get it notified if necessary. It would also help to get the agreement signed by a witness, in case there is a conflict or disagreement in the future.  

As mentioned earlier, every aspect and condition concerning the transaction of borrowing and lending a loan amount should be stated clearly before you agree to lend them money. Do not agree to lend the amount without considering the long and short-term consequences of it.

Take some time, analyze your savings, monthly expenses, and other finances, and come with a safe amount which you can lend without hurting your finances. After this, think about how you would like the loan to be repaid, do you want the entire amount returned in monthly transactions or would you like it all at once. Specify these requirements to your family member before lending the amount. 

In simple words, lending money to a family member should never be taken casually. You must consider each and every point when you are deciding with this regard. Remember that a written agreement is the best way to ensure that your loaned amount will be returned to you as per the conditions specified by you. It sure is a nice gesture to help out a friend or family member in need, but the relevant pitfalls and risks should be considered and minimized wherever possible.

Finally, you can lend and borrow money from your family members and friends without worrying about the tax-implications as all loans (whether with or without interest) are not tax applicable. However, history and experience show us that money has usually been a source of conflict between family members and close friends. So, more than the tax implications of lending money, you should be concerned about how your relationship might change.