Friendship ends with money: How to avoid disputes over personal loans

Expert tips - Friendship ends with money: How to avoid disputes over personal loans

For some people, family and friends are a safe bank. If things get tight financially, they can always borrow money from them. This is convenient because, unlike banks, relatives don't want to see proof of salary or bank statements to check creditworthiness. It is also usually cheaper because many people in close circles do not have to pay interest or provide collateral.

However, a personal loan can quickly go wrong if you blindly trust in family ties, warns lawyer Daniela Bergdolt, Chairwoman of the Banking and Capital Market Law Working Group of the German Bar Association. "Many people refrain from putting a loan in writing. This becomes critical if the money is not repaid." Conflicts often arise as a result.

In theory, there is no need for a contract if family members or friends lend each other money. But it still makes sense. "You should have very clear rules about the loan so that there are no misunderstandings. This is even more important in the family circle than when you lend money to strangers," says Bergdolt. Nobody should interpret this as a sign of a lack of trust. Rather as an attempt to protect the relationship. After all, many friendships and family ties have already been broken over arguments about money.

Avoid disputes over personal loans: A self-drafted contract is enough

A personal loan can be regulated quite simply. A self-drafted contract is sufficient. It should state in simple terms what amount is to be borrowed from whom and for how long. If you don't have the confidence to draw up such a contract yourself, you can also obtain a free sample from the Internet.

It is important to state the names and addresses of both contracting parties and to record in writing that the money will be repaid. It makes sense to agree a fixed date for this or even a repayment plan for larger sums. This prevents arguments about the money if there are differences of opinion about when the loan should be paid off.

If, on the other hand, a loan is open-ended, it only has to be repaid after it has been terminated. For the debtor, this means that they have to repay the sum in one go within three months. This is not always feasible for larger sums. Both lender and borrower must sign the contract. It is best to transfer the borrowed sum afterwards. This way, the loan can be proven in the event of a dispute. If it is handed over in cash, this should also be recorded in writing and receipted.

Caution: The tax office may charge gift tax

In the case of loans within the family, it is also advisable to discuss this with the other family members. "Unequal treatment between siblings is always difficult. That's why you should never hide a personal loan, but rather disclose all agreements," advises lawyer Bergdolt.

Unlike a bank, relatives or friends do not have to charge interest on borrowed money. This is certainly what many people count on when they pump their friends and family. But this can backfire. If no or very low interest is charged, the tax office can interpret a personal loan as a gift. This is not a problem as long as the tax-free amount is adhered to. For children, this is 400,000 euros within ten years, grandchildren may receive 200,000 euros. Friends and distant relatives, on the other hand, only have an allowance of 20,000 euros. If the amount exceeds this, gift tax may be payable.

It is therefore advisable to charge interest on personal loans, especially for larger sums. "This must correspond to a standard market level, as would also be agreed with third parties such as banks. Then the interest can even be declared to the tax office," explains Bergdolt. This means that the lender should base their interest rate on the current interest rate that a bank would charge for a loan. They must report their interest income to the tax office with their tax return. This is subject to 25 percent capital gains tax and, if applicable, solidarity surcharge and church tax, just like the income from other financial transactions.

However, interest income is exempt if the lender has not yet exhausted their saver's allowance of 1000 euros. Anyone who borrows money and pays interest on it can save tax if they use the borrowed capital to earn money. This is the case, for example, if the borrower uses it to buy an apartment and then rents it out.

You should only lend money to friends and relatives if you are sure that they will pay it back. It can still go wrong. "In an emergency, you have to take legal action - even against relatives or friends. You have a better chance if there is a contract for the loan," explains Bergdolt. However, she recommends trying out-of-court mediation first in the event of disputes in close relationships. If the repayment falls through, the lender is often left with the loss. If there is no money to pay off the loan, nothing can be seized. Nevertheless, if the loan is definitely not repaid, the lender can offset its loss against other investment income and thus save tax.

Editor's note: This article first appeared on "Capital".