Lending Money to a Friend — Strengthening the Bond or Destroying It?

If you should, and when you should.

The conventional wisdom goes that one must never lend to a friend — or risk losing the friendship. Does this wisdom still stand in a time where having a stable income and some savings is something only a few of us are blessed enough to have?

In a single word, the answer is no. The situation has deteriorated to a point where even otherwise ‘responsible’ people, who worked good jobs and lived within their means and kept their heads down, are floundering. The fact that some of us have kept our jobs has more to do with which industry we happened to be working in, and less with our supposed importance. The conventional wisdom needs to upgrade.

But it is certainly not a decision that you should take lightly, because how you handle it will have a lasting, if not permanent, impact on both, your money and your friendship. All of us have seen situations where otherwise healthy relationships have been destroyed because of money. After all, when even marriages can’t survive such conflict, how will friendship?

Here are some things you must weigh while deciding if you must lend, and if yes, then how:

1. Can you afford to lose the money?

The sad fact is that there is always a chance of default while lending to friends. It may be because of many reasons, some of which are unavoidable, and others which we can minimize.

When lending, assume the worst. Is it a sum of money, even if substantial, that you can afford to lose? If you never saw it again, would your life be affected?

More importantly, in the current situation, this question assumes a lot of significance. If you are yourself in an industry that may be affected, no matter how deep your friendship, lending the money will be disastrous — if not immediately, then at the time when you need your money but your friend can’t pay it back.

If the answer to this question is yes, then it takes a lot of pressure off while lending. You can truly give the money to your friend without increasing your own anxiety about the future — and that is a win-win.

If not, your friend would appreciate the truth, instead of being blamed later when you are struggling for money which they can’t repay.

2. Does your friend really need the money?

This is an awkward one, because who are we to judge our friend’s needs? At the same time, you are not being a good friend if you are enabling bad money habits.

You don’t need to ask your friend this, but it would surely be obvious from the way their lives are going. For example, if they have a dual-income household with no dependents, it is unlikely that they need the money barring any emergency. On the other hand, someone who has been out of a job for some time may need it.

A good friend would, while asking you to lend, also explain why they need the money and how their current income is not sufficient. Although no one owes you an explanation, a bit of context regarding why you are being asked for help, makes things slightly more comfortable all around. It would be more comforting to know that you are helping out in a genuinely unfortunate situation, and not digging a financial grave for both yourself and your friend.

3. Do they need money or do they need financial help?

Yes, money helps — a lot. But in my personal experience, what people really need 9 times out of 10 is not cold hard cash — it is help with their finances.

Unless it is something like a medical emergency where cash is immediately required, try and understand why your friend is in this situation.

Here are some possibilities and what you can do about it:

• Are they struggling because they do not have a job? Could you review/pay to have their resume reviewed? Share their job search on your platforms?
• Do they simply not make enough to fund their life? Can you help them with brainstorming and setting up some extra cash flow? If they have some extra time on their hands, can you pay for them to handle some work for you — babysit your kids, walk your dogs, research your new article? Earning the money will surely feel better than borrowing it, for both of you.
• Are they drowning in debt? Help them to consolidate their debts, prioritize which one to pay off, or get a concessional balance transfer.
• Are they mismanaging their money? Help them out with the basics of budgeting, saving, and investing.
• Do they have too much tax being withheld? Help them claim it back by filing the returns correctly, as well as help them reduce their withholding in the future.
• Are they earning enough and spending within the limit, but are having trouble with liquidity? This often happens with freelancers, and you can help them set up budgets for their unique circumstances.

All of these things will help set your friend up for financial success, and not just get them through a tough spot for right now. What’s that about teaching a man to fish etc?

A simple way to teach the basics could also be gifting them a book — you can find a link to a handy little personal finance guide (authored by me) at the bottom. It costs less than half a coffee — and will save much heartburn on both sides.

In other words, before lending money, check if that is even a good fit for your friend’s problems. Helping a friend is great, but you can’t always throw money at problems and expect them to go away.

Here is a handy little checklist to see where your friend might require some help.

4. Are there any other sources?

In today’s world, there are multiple sources of credit. It is equally true that not all of them will be available to each one of us.

When a friend asks to borrow, it is important to understand how and why other sources of credit, formal and informal, are not available to them — or not preferred by them. There may be valid reasons for both situations.

• Are formal sources of credit like loans or credit cards not workable? Is it because they have already maxed these sources out — in which case, more money is clearly not the solution?
• Is it because they do not have access to these, due to reasons like not having a credit history? Can you teach them how to build a credit history along with helping them out with money for the time being?
• Is it because they need the money due to a liquidity crunch — meaning they will certainly earn the money in the near future but need to spend right now? This could be the case when sudden emergencies require more money than is available immediately, in which case they would be able to repay you fairly soon and with certainty.
• Is it because they want to avoid the interest payments? This is a valid point, but in such cases, it is essential to understand how they plan to pay you back — is it only the interest component they have trouble paying (in which case you could help by not charging any), or is it also the principal (which means it will lead down the road to friendship disaster)?
• What about informal sources? Why is your friend not borrowing from their spouse/family? Are they all in the same boat, or are those sources tapped out?

While it is okay to lend to a friend even if other sources are available, it is important to know how and why the ask has landed at your feet, instead of the more conventional doors.

5. Can they repay it?

The big one. While it is perfectly alright to lend without expecting repayment, it is crucial that both parties are on the same page.

If the borrower thinks it’s a gift whereas the lender expects the money back, it will lead to a lifetime of resentment on the part of the lender when they see their friend enjoy a life based on ‘their’ money.

If the borrower thinks there is no time limit on repaying, because none was agreed to, but the lender has a timeframe in mind, which was never conveyed, it will lead to vehement judging on the part of the lender, each time the borrower spends on things ‘less important’ than paying them back.

Unsaid expectations of repayment also lead to all conversations becoming tainted— with the borrower expecting a reminder at all times, and the lender expecting some update regarding the repayment.

It is essential to set the boundaries in terms of the repayment — if it is expected at all, if it is expected purely on the borrower’s comfort, or if it is expected within the lender’s timeframe.

6. When will they repay it?

Continuing the previous point, if it is so decided that the loan is to be repaid within a certain timeframe, this needs to be communicated clearly at the time of the loan.

• What is your soft limit and hard limit? The soft limit being by when you prefer the loan to be paid off, and the hard limit being by when you require the loan to be paid off. This could also have to do with you wanting to put that money towards other goals after the ‘hard limit’, for example, maybe there is a school payment coming up. These plans of requiring the money by a certain date for specific purposes needs to be clearly communicated to afford them the seriousness they deserve.
• Do you want the payment at a go, or in installments, or do you want to leave that choice up to your friend?
• Is there a date by when you need the installments every month? How flexible are you with that? Are you planning to pay for something with the repaid money, in which case you can’t be flexible?

This point is where the majority of conflicts, even among well-meaning friends, occur. By having an admittedly awkward conversation at the very outset, you can save yourself months — if not years — of awkwardness in the future.

7. How will they repay it?

This is where you can go beyond being a mere lender, to actually being an amazing friend.

Understanding that a plan to repay will ease the inherently aggravating nature of such relationships, is important on both sides. If both friends can work a plan to comfortably repay the money, the rest of the journey will be a breeze.

Of course, for this step, the friends need to share a relationship that allows for such a plan. But if it does, it transforms the power dynamic from borrower-lender to that of partners wanting to achieve a common goal.

While finances are important, so are friendships. Openness and the ability to communicate clearly and sensitively can ensure that both remain unsullied by this crisis!

I have put together a handy little Personal Finance Crash Course e-book, covering everything from budgeting and investing, to retirement and goal planning. Click here to check it out, and thank you!