How to loan money to family or friends who have bad credit

Having no credit or bad credit is a difficult situation to be in. Your family or friends may be in a dire need of money and might come to you for loan. Which begs the question, is it OK to loan money to family or friends? This is a very personal decision. If you do decide to loan, consider these tips on how to loan money to family or friends with bad credit the proper way.

Charge Interest When Loaning Out Money

While this may seem counter­intuitive to the tenets of family and friends, it’s not to the business of money. After all, you’re being asked to take some of your savings and instead of banking it where it would earn interest or investing it where it would also likely accrue interest, to loan it to a friend or family member. You deserve to get a reasonable return on your money, maybe something in between what a bank account would yield and the return of a riskier investment.

Avoid Tax Implications by Charging Interest

By charging interest on a hefty loan, you will avoid any tax complications with the IRS. Imputed interest is an interest value considered by the IRS to have been paid for tax purposes, even if no there was no interest. The IRS uses imputed interest to collect tax revenue on loans that don’t pay interest or an interest very low. A loan with an interest rate below the standards set by the government is known as the Applicable Federal Rate or AFR. These rates change on a monthly basis and are published by the IRS online.

Imputed Interest Loans

Imputed interest rules apply to:

  • gift loans
  • compensation related loans
  • corporation shareholder loans
  • tax avoidance loans

Motivation to Repay the Money Loan Faster

Another good reason to charge family and friends an interest on your money loan is to keep them motivated. They will be more motivated to pay back the loan faster if it directly affects their pockets. By knowing they can repay the loan in a short amount of time, they will save money on interest as opposed to taking longer to pay off the loan.

Get the Terms and Conditions in Writing

What’s important here is that both parties are clear as to the terms—and terms are subject to applicable law. Just as it’s reasonable to ask for a return on your money, it’s also perfectly sensible to work out exactly when payments will be made, in what amount, and what will happen if they’re not made. Be upfront about the transaction and make sure both parties are clear on the terms and conditions. This is especially important if you’re talking about a sizable chunk of money. Better that you both know exactly what’s supposed to happen and when rather than have an uncomfortable gray area exist between you like a gigantic elephant in the room.

Schedule Automatic Money Payments for the Loan

Avoid awkward conversations or worse yet, awkward silences by setting up an electronic fund transfer from his or her bank account to yours. That way, not only is there a record of each payment for everyone’s peace of mind, there’s less chance of a payment being missed. Just make sure this is clear when discussing terms and conditions. You’ll want to make sure is that the receiving party prevents overdraft fees to not make matters worse with their financial institution.

Practice Makes Perfect Regardless of No Credit or Bad Credit

While personally loaning money to family and friends won’t improve their credit score, they may develop good habits to repay the money, become more responsible, and improve your relationship with them since you were willing to lend them your hard­ earned money. No matter if your family member or friend has no credit or bad credit, there are 8 steps they can take today to improve their credit score. In no time, they should be on the right path to improving their situation.

Believe it or not, there’s a science on how to loan money to family and friends to do it the right way. These tips will help ensure to make the transaction when loaning money out as smooth as possible. If you still find you’re uncomfortable borrowing from a friend or family member, take the emotion out of the equation by directing them to a personal loan for people with bad credit.

Would you lend money to a family member or friend if they needed the money?

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