Many people utilize their extra cash by providing short term loans to their relatives and friends to meet their financial requirements. After the COVID-19, most people were financially and took/gave loans from/ to their relatives. However, offering loans to known people can be extremely risky. It can affect a personal relationship if the person does not return the loan.
So, the question arises of how to lend money legally in India to friends and family members to minimize its risk. If you ask the same question, then most people suggest that you keep it in writing. And this is the best way to make a small loan agreement or the promissory note to ensure you have given the loan to someone, and the same person will return the money after some time.
Is It Legal To Lend Money To Your Friends And Family Members?
It is legal to lend money to friends and family members, and once you lend the loan, it becomes their legal obligation to repay on time. You can also take legal action when needed, but before that, you need to understand some crucial things we will discuss in this blog. The loan offered by you has the same legal importance as the bank loan has. But whenever you lend money, then you must make a promissory note, and you both must sign that promissory note. However, you may hesitate to sign the promissory note with your loved ones. But still, it is worth doing if you do not want to face any consequences in the future.
How To Lend Money Legally in India?
You have understood that lending money for good reasons is legal. Here are the steps you can follow to prepare the legal agreement to minimize the risk of offering the loan.
You should go for the promissory note if you provide a loan on a simple term basis and want to keep a record. In this case, section 4 of the Negotiable Instruments Act, 1881 comes into existence. Your borrower signs the instrument you created by mentioning clear guidelines of the loan.
While creating a written proof, you need to add some crucial points, such as the name and address of the party that agreed to get a loan from your side. The principal amount and interest rate, if any, with the repayment terms, monthly or annually. You can also add on late fees and another term which you want to highlight. And at last the signature lines for both the parties, the lender and the borrower.
Once your promissory note gets ready, you can check the terms and analyze whether you need to add or subtract something. You can look for the collateral security, involvement of the third party, and another key you want. At last, you both can check the instrument sign and take judgment from the small claim court.
Do I Need To Pay Tax If I Borrowed Or Lent Money?
In most cases, the gifts and loans from family members are not taxable. However, in gifts, the person needs to pay tax if the gift amount crosses Rs50,000 from a friend in a financial year. Although, if it is borrowed money and needs to be paid after some time, there is no tax.
For example, if your friend gifted you Rs70,000, now you will be required to pay tax on this amount, but if he lent the money, then there is no tax; it is tax-free.
4 Key Points For Both Lenders And Borrowers
- If the loan is interest-free, then there is no tax provision for the lender and borrower.
- However, if the lender has charged interest or is willing to charge, they will be required to pay tax on the earned interest.
- However, the borrower has to pay tax or not; it depends upon the purpose of the loan. If the borrower uses the loan amount for personal use, they will not be getting any tax benefit.
- The loans acquired by family members and friends are not eligible to get a deduction under section 80C.
5 Things To Consider While Lending Money
You can consider many things to safeguard yourself from any uncertain loss; here are a few of those.
1. Pay The Loan Money Through Check Or Bank Transfer
The most important thing you need to consider is that the cash transaction has no proof. And income tax has allowed only Rs 20,000 personal lending in cash. Therefore, you can look for bank transactions and use your check to transfer the money to the borrower’s account when you need to lend money.
2. Make a Legal Agreement As Discussed Above
it is a wise choice to have a legal agreement in the form of a promissory note or any other instrument you think fits. It helps you avoid any awkward situation because you have promised to pay the loan money, and the borrower has promised to repay the decided money. However, making a legal agreement can be challenging, especially if your loved ones are asking for a loan but still you should try to make the same.
3. Look For Collateral If Possible
It is one of the everyday things that most money lenders prefer to look for collateral security such as gold, vehicles, land, or any other decided asset. You can also ask for the same because it will help you cover the loss if the borrower fails to return the lent money.
4. Identify And Note Down The Purpose Of The Loan
You should look for a loan because it will help you to understand whether you should lend the money or not. If the person is willing to start a venture, buy a home, car, or any investment, you can think of lending the money. But if the person has already taken a loan and is asking you to pay for the same. It would help if you avoided it, but it can be okay in the case of an emergency.
5. Involve The Third Party
Having fitness can prove that you have lent the money to the borrower and help you in the future if any mis consequences happen. Therefore, when you and the borrower sign the agreement, there should be a witness.
You can lend the money, and it is perfectly legal in India. However, it would help to stay tuned with the concerned tax liability and any similar reform that can affect the money lending legal and tax obligations. Also, while giving the loan or lending money, you can create a promissory note and consider looking for the terms we discussed above. So, if you think this article helped you, you can share this article with your friends to understand this crucial concept.