Fair Interest Rate on 2k Personal Loan to a Friend Personal Finance & Money Stack Exchange
Fair interest rate on $2k personal loan to a friend - Personal Finance & Money Stack Exchange #
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A friend wanted to borrow $2,000 from me and he promised that he would pay it back in a month. I’m about to lend him the money. How much interest should I charge that would be fair? I am not exper…
Frame challenge.
If you “lend” money to friends or family, consider it as lost, with a very small chance that by pure luck they will pay you back.
If they ask you rather than a bank it’s because the banks won’t lend them the money, and banks have (a) better ways of determining whether someone is trustworthy enough and (b) often better ways to get their money back (or at least part of it) if they don’t pay back (repossession). You don’t have either.
If this is for some kind of business venture, then do not lend them the money, invest in the venture. The chances you see your money back are probably not much higher (that’s why those investors are called “Friends, family and fools”), but at least if the business flourishes you can make quite a bit more, which may be worth the risk (though do not invest just because they are a friend, but because you have looked into their project and judged it at least somewhat viable).
If your friend is in dire straits, needing the cash just to keep afloat (to pay rent, to repay a loan or credit card bills…), then lending them money will not help them, it will just make a bigger hole in their finances. What will help them is education about better management of their budget.
If despite all this you still want to lend them money (remember, it’s really a gift disguised as a loan), then in many places there’s a maximum rate you can make them pay, beyond which the tax man will consider you are making money out of it, and will require you paying taxes on the interest received (or may even consider you are acting as a bank, which is often regulated). Or on the contrary there is a minimum interest rate, below which they consider it’s a gift rather than a loan.
In the US the relevant rate is the Applicable Federal Rate (AFR) set by the IRS. You can read more about it here.
The loan should be documented in writing (in some countries it needs to be declared to the tax authorities or notarised), just to make sure it’s not considered a git or a payment for services (income for the recipient) which would be taxed.
It’s illusory to think such an agreement could be used to get your money back, unless you manage to get some form of guarantee/lien you can use, but that’s probably a bit over the top for $2000 (and again, while a bank is used to handling those, you aren’t).