Writing a personal contract for a personal loan
October 31, 2011 12:00 AM   Subscribe

This week I'll probably be making a personal loan to a friend. Would like to have everything in writing, for both our sakes. Details inside.

A friend is a single mother, is 5 months from finishing her job training program, has run out of financial aid options from the school, and is in danger of having to quit her training due to lack of funds. She is studying to be an xray tech, so should be able to get a decent job fairly easily in about 6 months. I'll likely be making her a personal loan to help tide her over. Would like for us to have the details in writing before making the loan. Expecting to loan $2000-4000. It's more than I'd like to lose, but will not cause a financial hardship for me.

What I have so far:
- term of the loan. Thinking a total time period of 3 years to repay, first payment to be made in 10 months. Should leave her time to finish school and start working before owing payments.
- no interest. Just wouldn't feel right to be trying to make money off a friend in a tight spot.
- contact info updates. She's moved several times recently, with various roommate situations. I don't want to lose contact during the time of the loan. Should I ask to be kept up to date with her current physical address, or is phone/email sufficient?
- other expectations. Not sure how to phrase this part yet. On occasion, she pet-sits for me, and I pay her. If I ask her to pet-sit again, it would be the same arrangement as in the past. I don't want her obligated to me because of the loan, and I would still plan to pay cash, not deduct her services from the amount owed.
- receipts? I assume she'd be repaying by check. Should I provide her with a written receipt for each payment?
- confidentiality. We're both in the medical imaging field, although different areas. We know a lot of people in common. I don't plan to mention the loan to anyone, and I prefer that she not mention it either. There are a lot of weird interpersonal issues in the local departments, and I prefer to stay out of all that if I can. Too many nosy people happy to share the latest news.

What else? I know that this could still go bad, even with having things in writing up front. I understand that I risk losing the money, and possibly losing the friendship.
posted by dorey_oh to Work & Money (26 answers total) 3 users marked this as a favorite
Best answer: i can't really speak to the personal contract side of this, but as someone who has loaned money to friends in personal hardship as well as accepted loans from friends (none of which involved contracts) when i was in personal hardship, the only thing i would like to say is that if you really value this friendship and want to keep it, you have to go into it with the expectation that the loan may only ever be partially be repaid or never paid back. otherwise, don't make the loan.
posted by violetk at 12:14 AM on October 31, 2011 [20 favorites]

I know you say no interest, but one thing maybe worth considering is whether you should index the amount to the rate of inflation. Otherwise you are actually losing money.
posted by lollusc at 12:17 AM on October 31, 2011

Best answer: Other expectations: leave this out since the expectation is that it should not change any other aspects of your relationship.

Annual accounting: once a year you give her a summary of payments received and amount still owed. If she is paying by check, you probably don't need to give regular receipts.

What happens if she misses a payment? is unemployed? I did a family loan at the prime rate (as written up in the WSJ) and so missed payment just added interest to the amount owed (no other penaly though)

Make sure you talk with her about what you want to put in writing and get a verbal agreement first - it makes it warmer than just sending a piece of paper, especially if there is anything in it that concerns her.

Be really prepared to bite your tongue about how she spends her money as long as she (a) uses your money for tuition and (b) repays as agreed.

FYI, if you don't charge interest, the amount of interest otherwise owed would be considered a gift from you to her. Not enough to trigger gift tax but just so you know.
posted by metahawk at 12:26 AM on October 31, 2011 [2 favorites]

I should add that this advice is based on my experience with family loans of my own - not a lawyer or an accountant.
posted by metahawk at 12:27 AM on October 31, 2011

I know it's tough to plan for the worst with a friend, but make sure you know what you'll do if the time for the first payment comes and she can't spare the cash. Should she pay what she can? Wait till she can make a full payment?

For receipts, I would just make sure there is a record somewhere that you can both refer to that keeps track of what's been paid. Paper receipts seem a bit formal, I would just do this through email so you both have a copy.

Just a warning: A friend of mine recently owed me a few hundred dollars and took a few months to scratch it together. This was no problem to me since I didn't need the money, but when she finally paid me back she told me that she was so happy since she could stop avoiding my emails now. She'd been ignoring my friendly "how's it going?" texts and emails because she was so stressed about the money. Be aware that this could be more stressful for her than it is for you.
posted by auto-correct at 12:34 AM on October 31, 2011 [9 favorites]

Would it be possible to set up an automatic direct-deposit/automatic bank transfer situation between your accounts? That way Friend never has to think about exact amounts and dates to pay you back (as it'll always be on the same day/time and the same amount), the paperwork takes care of itself, and there may be lower stress levels all around.
posted by mdonley at 1:28 AM on October 31, 2011

I have never had one of these things go well, that I can recall.

Loaning money changes everything. It's the rare person who will pay it back, and you are over the threshold of value where it is worthwhile for her to ignore doing so. You'd be surprised how creative people can be developing reasons not to repay loans and how far away 'someday' can get.

If it's truly not an issue for you, perhaps you should mentally categorize it as a gift.

Some questions to ask: Why you? How come you were approached? Did you do the approaching?

What prior experiences has she had with borrowing/repaying from friends/family? If none, and particularly family, why hasn't she approached family first? If some, names/dates/references would be a good place to start.

Why does SHE need a loan? Are there no other options and is her financial condition a result of poor credit or bad financial management? If either, how does that illuminate your willingness to loan her money?

It's really hard to turn down things like this. I know.

But there are people who seemingly merit it, I also know.

All the paper in the world won't save you from someone's actions. It's a tactical mistake to think so.

This is a skill you need to develop.
posted by FauxScot at 2:48 AM on October 31, 2011 [1 favorite]

This is going to change your relationship with her.

I would suggest a different option: guarantee her for a loan at the bank.
posted by devnull at 2:56 AM on October 31, 2011 [4 favorites]

I have been in a similar situation on two occasions, albeit involving significantly smaller sums of money. Both times I have convinced my friends (with some difficulty) to accept the money as a gift. Giving a friend an amount of money I can afford has no risk as long as they understand that it's a gift and there is no expectation for them to pay me back.

Maybe rather than loaning her the full amount you could give her part of it and she could find the rest through some other means.
posted by neilb449 at 3:08 AM on October 31, 2011 [4 favorites]

I've received a business loan from a friend. We kept it very simple: annual interest rate of a low but reasonable amount, due in one year.

More complex than that, and I'd suggest that you probably don't want to do the loan, as the more terms there are, the more places you have for it to go wrong.

Keep it simple and both parties will be more likely to be happy at the end.
posted by zippy at 3:14 AM on October 31, 2011

If good friend whose company you'd miss if this goes bad:

Make her a gift of whatever the substantial expense is likely to be in the next six months, whether it's the final tuition bill or three months rent or whatever. Tell her if she really starts rocking in her new career she can repay you, or donate a like sum to a charity or tuck it into her kid's college fund if she wants to pay it forward. This assumes you're OK with this. For me, there are maybe half a dozen people I'd do this for, assuming I had the scratch.

Casual friend whose company you like but if they moved tomorrow to Costa Rica you'd not really be heartbroken:

I would keep terms, payments, etc. super simple and understandable. Personally, I'd just set the start date for repayments to be either immediately, with a modest payment amount, or set them to start only after your friend gets a job in their new field. I feel the strongest chance for this thing to go sour is if they graduate and cannot find a job for months.
posted by maxwelton at 3:29 AM on October 31, 2011 [2 favorites]

I recently loaned much less to a friend (a few hundred). I classified it in my own mind as a gift, since I value her friendship more than the money. She paid me back about $100/month, and I sent her an email each time I got a check, with the amount and balance. It felt a bit like overkill, but I wanted to keep everything as clean as possible.
posted by GenjiandProust at 4:49 AM on October 31, 2011

That's not 'loan to a friend' money, imo.

If she can't get a loan, she's stretched to the limit, and she's not going to be able to pay you back. She's probably going to have a huge amount of debt already that she's going to have to start paying. She's probably going to need to buy a car, get an apartment, pay for child care, all those kind of things. Paying you back is going to be far down on the list. Are you willing to tell her she needs to write you a check instead of paying for groceries or buying a toys for her kids? Because that's the position you're going to be putting her in when she starts having to pay you back.

Cosign a loan for her and expect her to default on it. Or just give her the money and ask her to pay you back 'whenever'.

Anything more than that is asking for too much trouble, imo.
posted by empath at 5:27 AM on October 31, 2011 [2 favorites]

Best answer: Make sure you negotiate these terms with her. You are well within your rights to insist that it is done in writing, but everything else should be discussed. If you are dictating terms, it makes her feel as though she is the subordinate in the relationship (the friendship and the business relationship). Also, if she gets into a position where she starts to feel like she can't repay the loan, it is easier to screw "the boss" versus someone you made an honest agreement with.

As for the interest thing, that's just a matter of culture, I think. I know some people who would never charge interest to a friend (including me), but I also know other people who wouldn't think of NOT charging (or paying) interest on any loan. A workaround for that, and to give your friend some agency in the process, is that if she insists on paying some interest, make it an option on her behalf. If she can't make the full payment that month, she can pay some token amount of interest that month. This does two things: compensates you for extending the payoff deadline for another month, and allows her to "skate" for a month without feeling like she has gone into default. Because it is easier to give up on paying a loan that's already in default, and because it's probably impossible to catch up on a missed payment.

Let's just say you choose something like 2%. OK, it's a few months into the payback and she has the balance down to $3500. She needs to skip a month. 2% per year is 0.16667% per month. $3500 times that is $5.83. That's nothing. But it allows both parties to remain squared up for that month.

I would suggest a different option: guarantee her for a loan at the bank.

I wouldn't do that, because then if she doesn't pay back the loan, you are on the hook for the principal AND interest. And probably some penalties for late payment and such. And your credit report will reflect any late pays.
posted by gjc at 5:43 AM on October 31, 2011 [4 favorites]

I wouldn't do that, because then if she doesn't pay back the loan, you are on the hook for the principal AND interest. And probably some penalties for late payment and such. And your credit report will reflect any late pays.

True, but she'll also be dealing with the bank sending her formal bills and notifying her of late payments, etc, not you.
posted by empath at 5:48 AM on October 31, 2011

Your assumption that a radiology tech would easily find work might not be as accurate as you wish. I know someone who graduated last year (May 2010) and is still looking for work, as are many of his classmates.
posted by Nickel Pickle at 7:01 AM on October 31, 2011 [1 favorite]

One thing that metahawk touched on - you're going to have to develop some selective blind spots where she's concerned. Once you lend it to her, it's her money not yours, and she spends it however she wants. This will, honestly, affect your friendship. Not only in the event that something goes wrong and she can't pay you back, but even if she's on-schedule and making payments. It will be very very hard to see her on a social occasion and not have the thought cross your head that maybe if she weren't buying herself a $9 margarita at this bar night she'd be paying you your money back. Not that you'd take those thoughts seriously, but they'll probably still cross your mind. Basically that if you would personally put paying off a loan from your friend as a really really high priority, it will be hard to see anything that indicates that your friend is not prioritizing paying you back in the same way.
posted by aimedwander at 7:06 AM on October 31, 2011 [4 favorites]

If she's 5 months away from finishing and you estimate she should be able to get a job within 6 months, then it's possible she still won't have a job at the 10 month mark for the first repayment. As someone else pointed out, it's possible she might not get a job at all.

Perhaps make it where the first payment is due 2-3 months after she gets a job?
posted by cali59 at 7:18 AM on October 31, 2011 [1 favorite]

Best answer: Just a data point here: I've been on both sides of this kind of situation and it worked out fine every time. Simplicity, clarity and transparency were key--and not riding herd too closely on the other person. If losing the money or the friendship would hurt you, I'd decline to make the loan. If you're cool with it either way, it's a nice generosity. Good karma.
posted by fivesavagepalms at 7:51 AM on October 31, 2011 [1 favorite]

For what its worth, I have loaned money and been loaned money (not quite that much, but three figures). I made it clear that I would only accept the money if I was not judged on what I bought, and I wasn't. I was paid the money I borrowed back by giving whatever I could when I could, and was paid the money I lent back the same way. No friendships were affected, there were no arguments and everyone was happy at the end.

Of course, I suspect this isn't exactly usual, but I wanted to point out it CAN be done and expecting someone to pay you back isn't unreasonable unless they have a prior history of "forgetting" debts. Don't hassle them for the money, don't judge what they choose to spend their last fiver for the month on, don't bring it up except maybe yearly or quarterly as a gentle reminder, and it shouldn't affect the friendship.

I'm not sure I'd want to be close friends with someone who would take my money and not bother to pay me back anyway, if I'm honest.
posted by stillnocturnal at 7:56 AM on October 31, 2011 [1 favorite]

The best advice I have ever had about "lending" money to a friend was this:

If you want to remain friends with the person, don't expect to be paid back. Think of it as a gift and only "lend" as much money as you are willing to outright give the person. If they pay back all or any of it, consider that pennies from heaven. But if you feel like you must be paid back, then either don't make the loan or be prepared to lose a friend. Because they wouldn't be in the position where they needed to borrow the money from you if they were likely to be in a position to pay it back.
posted by slkinsey at 10:50 AM on October 31, 2011

All of this, plus - if you're in a related field, can you get the ball rolling on her "interning" with that department while she finishes her training? Even if she does it for free, it's a foot in the door for her new career. You don't have to be meddlesome, just mentoring. If they don't hire her, the clinical experience on the resume will count as more than a diploma alone.
posted by halfbuckaroo at 11:15 AM on October 31, 2011

My advice is much like violetk's, if you value this friendship, please do not lend her this money if you have any expectations of getting it back in full. Lending and borrowing money is the easiest and fastest way to kill any kind of relationship. You say it wouldn't be a hardship to lose this money if it never comes back to you - then gift if to her. If she pays it back, then great. If not, then you did something nice for your friend. Otherwise, I can almost guarantee it will not end well.
posted by patheral at 1:40 PM on October 31, 2011

Your wanting to keep the loan secret is a big red flag, and your reason for doing so is unpersuasive. So what if people want to share the latest news? Can you tell us what, exactly, would be perceived as improper if others knew?

I am one of many who has been in your situation---for better and for worse---you absolutely must consider the money a gift unless you are willing to lose the friendship.
posted by drdanger at 7:34 PM on October 31, 2011

Best answer: You should ask for a promissory note for one reason: if the debt becomes uncollectable you can sometimes write the debt off your income taxes.

I loaned a family member some money. He is a CPA and he knew right away that the idea was a good one for exactly that reason.

There was no expectation that he'd be able to pay me back, but he did.
posted by jet_silver at 7:36 PM on October 31, 2011 [1 favorite]

"Expecting to loan $2000-4000. It's more than I'd like to lose, but will not cause a financial hardship for me."

Don't loan her the full amount if it is more than you are comfortable with.
She will find another lender--especially if she is then only asking for $1000 to $2000.

Also, depending on a future job to pay you back makes this a riskier proposition; this is another reason to scale back the loan until it is closer to "gift" level.
posted by calgirl at 11:44 PM on October 31, 2011 [1 favorite]

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