Why lending to friends goes wrong
Money changes relationships. Not because people are dishonest, but because informal loans have no structure. There are no due dates, no records, and no neutral third party holding anyone accountable.
When a friend borrows $5,000 and says “I'll pay you back soon,” both sides walk away with different expectations. The lender starts keeping a mental ledger. The borrower assumes there's no rush. Six months later, neither person wants to bring it up.
It's ambiguity. When there's no written agreement, no payment schedule, and no documentation, small misunderstandings become major resentments. The fix isn't trust — it's structure.
The solution is treating the loan like a real financial transaction, even if the other person is your best friend, sibling, or business partner. That doesn't mean being cold. It means being clear.
Before you lend any money
Before you write a check or send a transfer, run through these questions honestly. They'll save you from a situation you can't easily undo.
Only lend what you could walk away from. If losing this amount would cause financial stress, it's not the right move — regardless of the relationship.
This isn't a judgment question. It helps you understand the risk. If a bank won't lend to them, you should at minimum understand why.
Before money changes hands, both sides should agree on the amount, schedule, and what happens if payments are late. Vague promises don't count.
If they stop paying, will you follow up? Or will you silently resent them? If you can't enforce the terms, consider whether a gift is more honest.
If you can answer all four confidently, you're in a good position to lend. The next step is making it official.
What to put in writing
A written agreement is the single most important thing you can do when lending to a friend or family member. It protects both sides, eliminates ambiguity, and creates a record you can reference later.
It doesn't need to be a 20-page contract drafted by a lawyer. But it does need to cover the basics. At minimum, your loan agreement should include:
- The exact loan amount
- A repayment schedule with specific due dates and amounts
- Interest rate (even if it's 0%)
- What happens if a payment is late or missed
- How payments are confirmed (bank transfer, platform, etc.)
- Signatures from both sides
This doesn't make the relationship transactional — it makes it professional. Think of it as protecting the relationship, not threatening it. Both people know exactly what they agreed to, and there's no room for “I thought you said…”
Some people use templates or dedicated tools to formalize this, so neither side has to manage reminders or documentation personally.
Interest rates and the IRS
Charging interest to a friend feels uncomfortable, but the IRS has specific rules about private loans that make it worth understanding.
The Applicable Federal Rate (AFR)
If you lend more than $10,000, the IRS expects you to charge at least the Applicable Federal Rate (AFR). This is a minimum interest rate published monthly by the IRS, broken down by loan term:
What happens if you don't charge interest?
For loans over $10,000 with no interest, the IRS may treat the forgone interest as a taxable gift from lender to borrower. You could owe gift tax if you exceed your annual exclusion ($18,000 per person in 2025).
For loans under $10,000, the IRS generally doesn't require interest. But even small loans benefit from a written rate — even if it's 0% — because it documents the intent and distinguishes the loan from a gift.
Practical advice
If you want to keep things simple, charge the AFR. It's often under 5%, which is well below any bank rate. Your borrower gets a fair deal, you stay on the right side of the IRS, and you've documented a legitimate loan.
How to structure repayment
“Pay me back whenever” is the worst repayment plan you can set. It feels generous in the moment but creates anxiety on both sides. The lender wonders when they'll get paid. The borrower feels guilty but has no deadline to act on.
A real repayment schedule solves this. It defines:
- How much is owed per payment (fixed monthly amount)
- When each payment is due (specific calendar dates)
- How long the loan runs (total number of payments)
- How interest is applied (amortized, simple, or interest-only)
Common payment frequencies
Most common. One payment per month on a set date. Easy to remember and budget for.
Every two weeks (26 payments/year). Helps borrowers who are paid biweekly align loan payments with income.
Smallest individual payments. Works well for short-term, smaller loans where the borrower needs maximum flexibility.
The most important thing is that both sides agree upfront and the schedule is documented. A borrower who knows they owe $450 on the 15th of every month is far more likely to pay on time than one who owes “about $5,000 at some point.”
How to track payments
Once money starts moving, you need a way to track it. “I'll remember” doesn't scale past the first payment, and Venmo transaction notes aren't a financial record.
What to track for each payment
- Date the payment was made
- Amount paid (principal vs. interest breakdown)
- Remaining balance after the payment
- Whether the payment was on time, late, or partial
- Method of payment (bank transfer, cash, etc.)
This documentation matters for three reasons: it prevents disputes about how much is owed, it satisfies the IRS if you ever need to claim a bad debt deduction, and it keeps the borrower informed about their own progress.
Spreadsheets vs. dedicated tools
Spreadsheets work for the first month. Then life gets busy, you forget to update a cell, and suddenly neither side is sure what the current balance is. Dedicated loan management platforms automate the math, send payment reminders, and create an audit trail that both parties can access.
How to protect the relationship
Late payments are the number one reason personal loans damage relationships. Not because the money is late — but because the lender has to become a debt collector to someone they care about.
How to handle it
Build a 3-5 day grace period into your agreement. Payments due on the 1st aren't considered late until the 5th. This accounts for real life without rewarding negligence.
A system-generated reminder is far less awkward than a personal text. Automated notifications remove you from the equation entirely.
If a payment is late, record it. If you restructure the loan, document the new terms. This protects you legally and keeps both sides aligned.
Your agreement should define what happens after 30, 60, and 90 days of non-payment. It doesn't have to be aggressive — but it should exist.
When reminders and payment tracking come from a system rather than from you personally, it removes the interpersonal tension entirely. The borrower sees a professional notification — not a passive-aggressive text from their friend.
Tax rules and bad debt deductions
Personal loans between individuals have real tax consequences that most people don't think about until it's too late.
Interest income is taxable
If you charge interest, that income is taxable and must be reported on your federal return. Even at low AFR rates, you're legally required to report the interest you receive as ordinary income.
Claiming a bad debt deduction
If the borrower stops paying entirely, you may be able to claim a non-business bad debt deduction on your tax return. But the IRS has strict requirements:
- You must prove the loan was genuine (not a gift)
- You need a written agreement documenting the terms
- You must show you made efforts to collect
- The debt must be totally worthless (partial write-offs aren't allowed for non-business debts)
Non-business bad debts are treated as short-term capital losses, limited to $3,000/year against ordinary income (excess carries forward). This is another reason why documentation matters — without a written agreement, the IRS will almost certainly deny your deduction.
This guide covers general principles. For your specific situation, consult a CPA or tax attorney. The key takeaway: document everything, and treat the loan like a real financial transaction.
Frequently asked questions
Should I charge interest when lending to a friend?
You can, but you don't have to. If you lend more than $10,000 and don't charge interest, the IRS may treat the forgone interest as a taxable gift. The safe approach is to charge at least the Applicable Federal Rate (AFR), which is a low minimum rate published monthly by the IRS.
Do I need a written agreement to lend money to family?
Legally, verbal agreements can be binding — but they're nearly impossible to enforce. A written loan agreement protects both sides by clearly documenting the amount, repayment schedule, interest rate, and what happens if payments are missed. It also satisfies IRS requirements if you ever need to deduct a bad debt loss.
What should a personal loan agreement include?
At minimum: the loan amount, interest rate (or 0%), repayment schedule with specific due dates, late payment terms, and signatures from both parties. Stronger agreements also include collateral, default remedies, and governing law. Platforms like Accorda generate all of this automatically.
Can I deduct a bad debt if a friend doesn't repay me?
Yes, but only if you can prove it was a legitimate loan, not a gift. The IRS requires documentation showing a genuine debtor-creditor relationship — a written agreement, evidence of repayment attempts, and proof the debt became worthless. Without a written agreement, the IRS will almost certainly deny the deduction.
What's the best way to track loan payments from a friend?
Dedicated loan management tools like Accorda automatically generate amortization schedules, track each payment, send reminders, and maintain a full audit trail. This is more reliable than spreadsheets or Venmo transaction notes, and provides the documentation you'd need for tax purposes or disputes.
How do I ask a friend to pay me back without ruining the relationship?
The best approach is to establish structure upfront — a written agreement with specific due dates removes the need for uncomfortable conversations. If you're already past that point, using a neutral platform to send payment reminders takes you out of the middle. The reminder comes from the system, not from you personally.