Maybe your friend has a business idea and could use some seed money. Should you contribute? Think hard. Just about everyone has some kind of story about a loan gone wrong, and it's often enough to end a friendship. "It can get very uncomfortable very quickly," says Lizzie Post, etiquette expert (and Emily Post's granddaughter) and author of How Do You Work This Life Thing? "You start to feel like you have a stock in what your friend does with his money. The lines get fuzzy." Here's your to-do list:
Pop the question. Why isn't your friend considering a bank? Maybe she doesn't know that some banks offer small loans, often at competitive rates. A good credit score can go a long way at the right institution. If the bank won't lend to her, find out why. Maybe you never realized that she's got $25,000 in credit card debt already, and that should certainly influence your decision. "It doesn't mean that you can't trust her with other things," Post says. "But maybe not with your money."
Don't say yes or no automatically. Tell your friend you want to consider his proposition and you'll get back to him. "That way the requestor knows you're taking time to thoughtfully come up with your decision," says Nancy Mitchell, owner of the Etiquette Advocate. "It shows respect."
Listen to your gut. Think about the relationship you have with that person. Do you have doubts that she'll pay you back? Do you need those funds for something else? If yes, then the answer to your friend's request should probably be no. "You don't have to hold out your bank statement and display it," Mitchell says. "You can just say, 'It's just not a good time for me. May I help in some other way?'" Another response: "I'm just not comfortable lending that amount of money."
Put it in writing. If you take the plunge, document your arrangement. What to solidify: the amount lent, full or partial payback dates. and interest charged, if any. Consider using a service such as Virgin Money (virginmoneyus.com), which will set up the loan for a small fee. For slightly more, Virgin Money will even handle collections for you. "It helps to preserve the relationship because everybody's very clear about what the rules are," says Mary Lacey Gibson, a financial planner in San Juan Bautista, Calif. For a free template, search for "simple loan agreement" at docstoc.com.
Cover your financial bases. If you're considering a sizable transaction (say, more than $10,000), consult a tax pro to make sure you're following IRS rules. You may need to charge interest to stay aboveboard. Even if you're not required, don't feel bad about tacking on interest — if your friend went to a bank, he wouldn't be sailing away with a 0% interest loan. "You can say, 'I could lend you this money, but it means I have to take it out of my savings plan,'" Mitchell says. "'Would it be all right if we put interest into the agreement?'"