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Ask Money

A friendly loan

Chris Farrell Dec 2, 2010

Question: A friend of mine has $10,000 in credit card debt he and his wife are paying off. Their interest rate is 21%, making monthly payment of $700. They both make a combined of about $180K a year. I am looking to find some money to invest and get a better interest than the banks 1% interest. I was thinking about loaning them the $10,000 to pay off their debt, in return they would pay me 10% interest. Cutting their interest payment in half, getting me a much better return on my money. Seems like a win/win. Any suggestion about how I should set this up? It there something I should look out for that I may be overlooking? What are the taxes on this? First Name: Arthur, LA, CA

Answer: Let me ask you this: Are they good friends? Do you value the relationship? If yes, I would be very wary of getting entangled in their finances. The really big risk is that you’ll lose a friend if they default on the debt. The other risk is that you won’t get your money back, or at least not all of it.

When I say there is a risk that they might default I’m not assuming any character flaws or bad acts on their part. No, emergencies happen. So do layoffs and unexpected expenses. That’s why its always dicey to mingle friendship and money.

However, you are far from alone in deciding it’s a good deal to turn lender. At least anecdotally, loans to family and friends are on the upswing for the reasons you mention: The debtor gets a lower rate and the lender a higher interest rate than they can make on their savings. It’s a win/win, assuming it works.

If you do decide to go ahead and loan them the money there are all kinds of legal forms on the web that you can use to create a contract. For example, Nolo.com, the self-help legal organization, offers guidance and promissory loan documents. The interest you receive is taxable (just like the interest you get on your savings account).

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