What to do when Lending Money to Friends goes Wrong

One consequence of the current economic upheaval is that credit is increasingly hard to get from banks. This and the fact that bank loans may be expensive means that we are likely to see an increase in informal “loans” being offered to friends and relatives. Typically, however, this will still be regarded as an option of last resort, due to its potential to put strain on a valued relationship. It is particularly fraught with danger since, typically, the person requesting to borrow money is probably doing so because they have got into financial difficulty and perhaps because they have been turned down for a loan by a bank.

What do we do, then, if we have lent money but the other person has failed to pay the money back? One of the problems with person-to-person lending is that is it almost always informal in nature, with no written contract and often no firm agreement on repayment scheduling. This means that the lender has effectively no legal recourse (or would have great difficulty enforcing any legal rights) should the other person fail to repay the money. You are therefore relying on the trust that exists in your relationship but, as good as that trust might be, there may be extenuating circumstances that mean that the other person can’t pay back the money.

As the lender, you have several options should you ever find yourself in this unwanted position. The first is simply to write off the money and put it down as a painful learning experience. You might take this option if the amount is relatively small (at least from your perspective) and/or where you don’t want the matter to descend into an ugly squabble that may ruin a relationship that you value. An example might be where you’ve lent money to your younger brother or sister. You should make it clear that you’re not happy with the outcome and that no more money will be forthcoming. Hopefully, the other person may be shamed into striving to pay the money back even though you’ve said that you’re prepared to write it off.

A second option is to speak to your friend about why he or she is having difficulties making repayments and offer some flexibility on when the payments need to be made or how much you are expecting in the first instalment. Open and honest communication is the key here and it’s important to try to remain calm. Rising tensions and accusations will only tend to make matters worse. Understanding the other person’s perspective may help to enable you to come to an arrangement that will mitigate the financial loss for you. This is essentially what banks do when a borrower gets into difficulty on a formal loan.

The third option is to go for an aggressive stance and demand that the other person pays up all they owe and that they do so within a stated time period. Whether you use this approach will depend upon how well you know the other person and how effective you think such an approach is likely to be. You should bear in mind that it may damage your friendship but you are hoping that a little short-term friction may be better than letting the situation fester into a more putrid sore.

In general, person-to-person lending is a risky business and often offers a lot of hassle and distress for very little reward. That is why we choose to take loans via banks. This doesn’t mean that there aren’t sometimes circumstances in which you may deem it to be worth lending the money. However, just like a bank should do due diligence when offering a loan, you too need to have thought long and hard about the merits of lending your friend or family member some money.