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The rules of lending money to a friend

Rules of lending money to friends

The people in our lives, like friends and family for the most part, enhance life. That’s what really counts. Money can bring people together, yet just as quickly it can ruin relationships. So it could pay to be cautious when family or friends come looking for a financial handshake. To make sure you don’t get in a pickle with pals over the purse, guest writer Peter Wood offers some sage advice.

We borrow from family and friends for gifts, bills and luxuries. One RMIT study even identified borrowing money from friends as a direct result of Australians’ mortgage debts.

 

In fact, it found 38 per cent of households have taken on more debt by borrowing from family and/or friends to cope with a mortgage. 40 per cent took an even more expensive approach and hit their credit cards. In contrast, only 24 per cent of households sought advice and just 14 per cent took on extra work.

With this attitude of ‘borrow first, worry about repayments later’, it could be disastrous for those dipping into the friend fund. Good mates who find themselves entwined in each other’s debt cycles need to set boundaries to protect that bond.

Assess your lending ability

If you have any hint of credit card debt, guess what? You’re not in any position to be lending from your savings. Your own debts need to be cleared first. And a RaboDirect National Savings & Debt Barometer survey, found many Australians have only one month’s savings or less in the bank to tide them over if they lost their job. So it’s okay to say no to lending money to friends. 46 per cent of working Australians are in the same position.

Set some rules

If you do decide to test friendships with a loan, be open about the terms. Get family members involved and include your partner and the partner/mutual friend of the loan applicant. You are more likely to have open discussions about the loan in the future if you aren’t lending in secret.

Don’t scoff at a contract

If hurting someone’s feelings with a contract becomes the least of your worries, that’s a good deal. Your contract can include whether you will ever modify the terms of your loan to meet new circumstances or whether you will charge late fees. If you are to go as far as to guarantee someone else’s loan, that nasty paperwork will certainly pile up against your name. If it’s a large amount of money, talk with a lawyer or get free legal advice.

Repayment plans

The good thing about friends is they can be flexible with a repayment schedule. If you are the lender, stipulate the terms and dictate when repayments will start to match each situation. Be flexible at the beginning in order to get someone on their feet. But don’t stay lenient with your ongoing terms.

Other exit strategies

Let’s say you decided to guarantee a home loan to get a long-time friend a start in property. Set in writing when you want the new home to be revalued. Assessing this equity could release your guarantee sooner than the life of a loan.

If a home has increased from $400,000 to $500,000, the applicant (perhaps now on a better salary), could use the equity as deposit and apply for the 80 per cent loan of $400,000. This method turns your commitment into an amicable five-year bond rather than a 30-year test of friendship. You will even save someone big money avoiding lender’s mortgage insurance once they are in a position to borrow with this 20 per cent deposit advantage.

So be careful when it comes to money and friends. Even lotteries recommend big winners take a grace period before collecting prizes to allow family and friends to get their financials in order. By taking your time and talking through any and all options with friends and family, you can be in the best possible position to offer them a fair loan – not a handout.