Circumstances may arise when you are either approached or are notified of an opportunity to lend money. Whether to make a loan should not be a rushed decision but rather made with regards to the following considerations.
Take the following examples:
Scenario 1 | Your friend Jo, an international student, has run out of money and has come to you for help. She does not have a permit to work and relies solely on her parents for income. You are thinking about lending her some funds until her parents send more money through.
Scenario 2 | You are one of the directors of a healthy burger restaurant chain. The board of directors has decided to expand to Queensland and is in need of funds. You are considering whether to lend some of your personal savings to the corporation.
Can you afford to lend money?
By lending up on a lump of money, you are giving up on the option to access extra funds in case of unforeseen circumstances. You should draft up a budget and consider how the loan would affect your lifestyle and whether you have enough leeway in the case of an emergency.
In the case of a loan to a business, the interest you receive should be declared as taxable income. You should, therefore, only account for interest as a source of income if it is inclusive of tax.
If the business is unsuccessful, you may lose your house if it has been used as security. Is the risk of losing your home too high? Where would you live? How will that affect your relationship with the person you have lent money to?
Will you get your money back?
If someone is coming to you for a loan it may be because the bank has refused to lend them money. The bank would have thoroughly assessed the person or business’s risk of default based on their credit health. The person or business may not have an asset valuable enough to act as security. If the bank thinks the loan is too risky, why shouldn’t you?
You may trust the person or business but they may be overly optimistic. You are the one at risk so you should be realistic.
Drafting a contract and getting legal advice
This is the most important part of the process. By this stage, you have decided to make a loan to the person or business and you turn now to the terms of the contract. Having the agreement in writing is crucial. It will allow for clarity, compliance and evidence in case of legal proceedings.
1. Draft a Loan Agreement
The agreement should include:
- whether it is a gift or a loan
- the loan amount
- when the loan is to be repaid by
- whether interest should be paid and if so, how much
- what to do if payments are delayed
- whether the debt can be converted into stocks, in the case of businesses
2. Get independent legal advice
Legal documents for loans can be complicated. You should consult someone who has no vested interest in the other party to go through the terms of the contract rather than simply relying on a bank representative. They should review the drafted contract with you in detail.
If you are in the process of making a loan to a business or a friend or family member, use our ‘Find Legal Documents’ to access our loan agreement templates.
Unsure where to start? Contact a LawPath consultant on 1800LAWPATH to learn more about customising legal documents, obtaining a fixed-fee quote from our network of 600+ expert lawyers or to get answers to your legal questions.