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Lending to friends and family can be risky

June 13, 2016 16:14 IST

MoneyDespite bad experiences it's not easy to ignore a relative or a friend is in need of financial help.

It is often said that the easiest way to lose a friend is to extend him a loan.

Many would have gone through the regret of lending to a family member or a friend, who didn't stick to the mutually agreed time of repayment, or worse kept requesting for more time, giving one excuse or the other, until you stopped expecting the money back.

Despite bad experiences it's not easy to ignore a relative or a friend is in need of financial help.

You can, however, stick to certain principles to avoid confrontations, complications or regrets later.

Money you can afford to lose

When a person requests Siddhartha Ray, a Central Government employee, for a loan, he always asks himself what is the maximum amount of money he can afford to lose?

Irrespective of the borrower's requested amount, he only extends funds within his means.

This way, he minimises his risks even at the cost of losing a relationship.

The idea behind this is not to prepare oneself for the loan going bad. It's not uncommon that the person borrowing the money delays the repayment.

Your financial plans should not get affected because you are relying on the person to repay by a particular date. You must, therefore, lend the amount which does not affect your budget or plans.

Know the purpose

Before lending, you must check the purpose of the loan.

It's not prudent that you cut corners to save and a person with bad money management reap the benefits.

Jayant Sharma, for example, got a call from his college friend, Vinay, whom he had not been in touch with for over a decade.

When they met, the friend requested for money as he had a temporary squeeze in his business.

He promised to repay in three months. Jayant didn't commit and said he will let him know later.

After returning home, he called up a few common friends to crosscheck.

They informed him that Vinay had borrowed money from them in the past but never repaid.

Many chronic borrowers usually lie about the end use of the money.

They even have dramatic stories to play with lender's emotions.

If you are not sure of the person's intention, do crosscheck.

These kind of borrowers are usually the ones that delay repayment and are difficult to deal with.

Lending for a cause

There are times when a person can approach you during an emergency, say for treatment of someone who is hospitalised.

During such times, many offer all the help they can afford, even beyond their means.

This is not the right approach.

If the borrower is a family member, you can involve others to and ask them for help.

This way you can not only arrange a bigger amount but also cut down on the risk of non-repayment.

You can also help the person secure a loan. Many don't know that non-banking finance companies lend to individuals even if they have a low credit score, but at a higher rate.

Usually, individuals approach banks, which have stricter lending criteria. On rejection, they lose hope.

However, don't become a guarantor to the applicant.

If he fails to repay, the institution can approach you for money.

You can also check peer-to-peer platforms to help the person get a loan.

Lending effectively

Lending can have an impact on your Income Tax when the borrower repays you. Say, the borrower deposits Rs 200,000 in your bank account.

The assessing officer might call you to explain the bank entry if the amount is significant.

That's why formalise lending if a considerable amount is involved.

You can draw a loan agreement that specifies terms and conditions of the loan and repayment schedule and also includes identity proof, and Permanent Account Number details of both parties.

Opt for funds transfer only through a banking channel.

Income Tax rules do not allow lending and borrowing in cash if the amount involved is over Rs 20,000.

The Income Tax department can levy a penalty equivalent to the loan amount, if you don't adhere to it.

Sometimes, you may be forced to lend despite not being comfortable. It can be on insistence from a close relative whom you cannot refuse.

In such situations, you can do paperwork that can come handy in future if the borrower tries to delay payment indefinitely.

You can use a simple promissory note, which is a declaration that the borrower has taken money from the lender and the lender is willing to return the same.

You will need to enter the amount of loan taken and how and when the loan will be repaid.

This could be a balloon payment covering several instalments or a bullet payment with a single end of the period payment.

This should be done along with a loan agreement that can be registered to give it more legal sanctity.

You can also ask for post-dated cheques (popularly called PDC) of proper amount from the borrower.

The promissory note along with PDCs may act as an effective instrument in protecting the interest of the lender.

If you have to approach the court, your case will be stronger with these instruments.

Also remember that if you receive more money than what you pay, say be way of interest, the lender will have to record this as income from other sources and pay tax.

Malhar Majumder is a certified financial planner

AVOID REGRETS

  • Only lend the amount you can afford to lose
     
  • What is the reason for the loan?
     
  • Introduce the prospective borrower to lending channels like NBFCs and peer-to-peer platforms
     
  • Approach others to be part of the lending
     
  • Maintain a loan agreement and use the banking channel to transact for Income Tax purposes
     
  • Draw up a promissory note and take post-dated cheques to protect from non-payment

Illustration by Uttam Ghosh/Rediff.com

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Malhar Majumder
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