What You Should Consider When Lending Money to Friends
Lending money always has a risk. Once you lend your money, there is no guarantee that you will be paid back. The stakes are even higher when lending money to friends or family members – not only you could lose your hard-earned money, but you also endanger important personal relationships.
I have lent money to friends several times in the past, but luckily I have always received my money back. In some occasions, my friends delayed their payments by quite a while. This made me uncomfortable and since then I have decided not to lend money to friends anymore. The only exception is when I want to help a friend out and don’t care if he pays me back or not.
However, there are many other people who have had trouble with lending money to friends and they have not received their money back.
Here are three stories about lending money to friends or people that you know well:
- The first story is about a loan gone wrong and how friendships were ruined. It is based on an interview with my dad who lent $20,000 to our family friends back in 2007. It’s quite an extreme case. Nevertheless, it teaches some good lessons and explains what can happen when lending money to friends.
- The second story is about lending $50 to a classmate at the age of 16. This is an interesting situation since the borrower does not have any income and you see each other on a daily basis.
- The third story is about lending $2,000 to your employee (and also a friend) who is in a very bad situation, but you don’t know the full story. It explains, what questions you should ask to get a better picture.
I have also summarized the key takeaways at the end of each story so you can use them in case you ever find yourself in similar situations.
Lending money to friends often results in a two-fold loss; both money and friend are gone forever. by William Henry Milburn
– Story 1 –
We Knew Them for a Long Time
12 years ago, when I was still a teenager, I used to play competitive tennis. Often, I would travel to tournaments with two of my best friends and our families would travel with us together. Both of my friends’ parents were my dad’s students many years ago when my dad was a young lecturer at a university, so we knew them quite well.
In 2007, we were preparing to go to a summer tennis camp in Germany. I was very excited and asked if my friends could come too. They said they would love to, but first, they need to ask their mother. Luckily, she accepted and we started planning a trip to Germany.
While planning the trip, our parents also discussed their work and different business ideas. My friends’ mother was well known in the local real estate scene. My dad owned a construction company and they both had a lot in common. One day, she explained that she has been looking for business opportunities in Italy and that soon she will be going there again. She suggested that we go to Germany without her.
A couple of weeks before we had to fly to Germany, she called from Italy and asked my dad to lend her $20,000 for one month, paying 10% interest at the maturity. She explained that she was currently selling her apartment, but needed extra money to finish a project in Italy. Easy money as she explained!
My dad thought it was a strange situation. Out of nowhere, our family friend had asked him for a loan. And not for a small loan, but $20,000 loan! It seemed odd that she only needed the money for one month and that she was prepared to pay 10% interest.
However, business for my dad was doing well at the time. He also knew that the tennis camp is quite expensive, so she wouldn’t pay for that without having a stable monthly income. Her kids actually lived in our house that week before we had to fly to Germany. She was, after all, an experienced businesswoman, specializing in real estate and our families were quite close. So my dad drafted a loan agreement, both of them signed it and he gave her the money.
Our Plans Have Changed
A week later we had to fly to Germany. Both of my friends never arrived at the airport and I went to Germany alone. My friends explained that their plans had changed and they had to fly to Italy to visit their mother. It turned out that they never bought the plane tickets nor paid for the tennis camp. I have never seen them or their mother since.
A month passed and we didn’t hear from them. Then 3 months, then a year. We managed to reach them via email and the friend’s mother made numerous promises to give the money back. She even sent us a repayment plan, but no payment followed. It has been more than 10 years and we have not received a single dollar from them. We know that they changed their surnames and occasionally change the country they live in. Who could have expected something like this? They were two of my best friends and just like that, one day they disappeared.
What Did We Learn From Lending Money to Friends?
- If something is too good to be true, then usually it is! Be cautious if someone is offering you a really good deal, especially if they know that you might have the money. In most cases, the deal will be much worse than presented to you. You should know that before making a decision.
- Lend just what you can afford to lose. In this case, $20k is too much to lose and be OK with it. I would avoid lending large sums of money to a friend in 99.9% of situations. Sometimes your friend might ask for $100 in an emergency. If you feel comfortable losing $100 and never mentioning it again, then help your friend out!
- Money goes easy when you have more of it. If my dad didn’t have a good amount of money at that time, he would never lend so much to a friend. Even if the repayment was in a month. So, if you manage to make a good amount of money in your career/business, be careful with it and spend it rationally (even better – invest). Other people will notice your success and from time to time will try exploiting you.
- Paperwork is important! If you lend larger amounts of money to a friend or anyone else, make sure to sign a loan agreement. The loan agreement is the only thing that still gives us a chance of ever getting our money back through the court.
- Don’t lend money to friends if you find it stressful. If you don’t want unnecessary problems in life or uncomfortable situations with your friends, then don’t lend money to your friends. There can be so many situations when things go wrong and you won’t get your money back on time or at all. Then, you will have to remind your friends about the loan and sometimes be pushy. If you know that this will be stressful for you, then it’s not worth it in the first place.
- Look at the risks first and only then at the potential return! This is very important. Many people often make decisions based on the potential return and disregard the risks. It’s very dangerous since the risk part is what largely determines your expected return. My dad wanted to make an extra $2,000 in one month but ended up losing $20,000. He didn’t think at that point about the state of the economy, the financial situation of the borrower and disregarded his own intuition – that something didn’t feel right.
Let’s look at the last bullet point mathematically. If we assumed that there is only a 5% chance of not getting our money back, 50% chance of getting our money back with no interest and 45% chance of getting our money back + 10% interest, then the expected return would look like this:
|Potential return scenarios||Probability||Expected return|
Would you lend $20,000, knowing that your expected return is $19,900? It doesn’t make much sense if you look at it mathematically. However, if you only look at the potential $2,000 return, then it can make a lot of sense.
– Story 2 –
I Can Make Some Extra Money
When I was 15 years old, I had started a business. I was still at school at that time and was the only one in my class making money. My classmates knew about my business and it didn’t take long for one of them to ask me for a loan.
One day at school, a friend of mine asked me for a $50 loan. He explained that he wanted to buy a jacket that was on sale and there was only one left. This was my first experience of lending money to a friend. The first thing I thought was that I could make a profit. I agreed to give him $50 for one month with a 20% interest (sounds like a shark loan type of deal). I also asked him to pay me back in weekly instalments of $20, starting from the second week. My friend happily accepted the deal and we shook hands. I figured, the worst thing that can happen, is he will ask his parents to pay me back.
The Conversation That You Don’t Want With Your Friends
The second week came and when I met my friend at school, I asked him for the first instalment of $20. He didn’t have the money and promised to pay me back at the end of the week. I talked with him at the end of the week and he explained that he could only pay me during the next week. This type of conversation continued for more than a month. There was a point where I would talk to him every day about the loan and he would give me more useless promises.
It was a very uncomfortable situation for both of us. He was trying to avoid me at school and I had to keep asking him to pay me back. At that point, my goal was to get any amount back and minimise my losses. I also asked him if he could just borrow from his parents. Apparently, he was afraid that his parents would find out and never considered such an option (my worst case scenario solution just vanished).
Just before the summer break, he paid me back the full amount of $60. I don’t know if he finally asked his parents or got the money from someone else. I consider myself quite lucky in this particular case. He could have easily not paid me back.
What Did I Learn from Lending Money to Friends?
If I faced this kind of situation now, I would ask myself the following questions before lending money to friends:
- Is it likely that the borrower will pay me back? In this case, it was very risky. My friend had no income and he was using the money for consumption – hardly an ideal situation. You can also ask if the borrower already has other debts. If he does, your chances of getting back your money on time or at all are much lower!
- Will I damage my friendship if my friend doesn’t pay me back? In this case, my classmate was not one of my best friends. Even though it was uncomfortable, I didn’t feel too bad asking him to pay me back every single day. If it was one of my best friends, it would have been very different. I wouldn’t like if my best friend tried to avoid me. I would also feel much worse asking him to pay me back.
The best thing to do is talking your friend out of borrowing money if you think he is going to use it on unnecessary consumption or on something much worse. It makes no sense buying something that you can’t afford! If your friend is not listening, then the least you can do is not lend him money.
Also, one way of helping your friends not to buy things they can’t afford is by not buying such things yourself. Envy (or benchmarking to your friends) + constant marketing around us, which promotes consumerism, can easily get many people tempted to buy overly expensive and generally useless things.
The holy passion of friendship is so sweet and steady and loyal and enduring in nature that it will last through a whole lifetime, if not asked to lend money. by Mark Twain
– Story 3 –
I’m in a Very Bad Situation – Please Help Me!
One of my friends who is a business owner was approached by his employee (also a friend) to lend him $2,000. The employee explained that his father might die and he really needs the money for the treatment. He promised to pay back within a year. My friend thought that this is serious and gave the money (they did sign a loan agreement). After all, it was the right thing to do!
Just before the one year expired, the employee left his job. He never paid back the loan. The worst part was what my friend found out later. The employee’s dad was never sick. The employee had serious gambling problems and he also lost those $2,000 in the slot machines. He was in so much debt from so many people that he had to run away to a different country.
How Do You Avoid Such Situations?
Would you lend money to your friend if he or his family members were seriously ill and needed help? Many people would and there is nothing wrong with that. The problem is when your friend is lying and needs the money for something else.
So how do you know if he is telling the truth? The answer is – you don’t! To avoid letting yourself down when lending money to friends, make sure of the following:
- Ask many questions. This way you can understand the situation better. If you are not sure, you can ask someone else if the story is true. Even though it is uncomfortable, you can also ask the borrower directly for some proof of the story.
- Offer to pay by yourself. When someone is asking money for a specific reason, offer to pay for it. You can always draw it up as a loan. If your friend asks for the money instead, then you can be more suspicious!
- Ask yourself – Can I afford to lose this amount of money? This is important so you don’t regret your decision later on. If you can afford to lose the money that you lend, then it will hurt much less when the borrower never pays you back.
In most cases lending money to friends is a bad idea! Think carefully before doing so. You don’t want to damage a good friendship.