For some people, family and friends are a safe bet. If things get tight financially, you can always borrow money there. This is convenient because, unlike credit institutions, relatives don’t want to see salary statements or bank statements to check your creditworthiness. It is also usually cheaper because many people in a narrow circle forego interest payments or collateral.

However, a private loan can quickly go wrong if you blindly trust in family ties, warns lawyer Daniela Bergdolt, chairwoman of the Banking and Capital Markets Law Working Group at the German Bar Association. “Many people choose not to record a loan in writing. This becomes critical if the money is not repaid.” This often creates conflicts.

Theoretically, there is no need for a contract if family members or friends borrow money from each other. It still makes sense. “You should make very clear rules about the loan so that there are no misunderstandings. This is even more important in the family circle than if you lend something to strangers,” says Bergdolt. Nobody should interpret this as a sign of a lack of trust. Better than trying to protect the relationship. Because many friendships and family ties have been broken because of arguments about money.

A private loan can be arranged very easily. A contract you have written yourself is sufficient. It should state in simple terms what amount is being borrowed from whom and for what period of time. If you don’t have the confidence to draw up such a contract yourself, you can also get a free sample from the Internet.

It is important to give the names and addresses of both contractual partners and to record in writing that the money will be paid back. It makes sense to arrange a fixed date for this or even a repayment plan for larger sums. This prevents tussles over money if there are different ideas 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 termination. What this means for the debtor is that he has to repay the sum in one fell swoop within three months. This is not always possible for larger sums. Both lender and borrower must sign the contract. It is best to transfer the borrowed amount afterwards. In this way, proof of the loan can be provided in the event of a dispute. If it is handed over in cash, this should also be recorded in writing and acknowledged.

If there are loans in the family, it is also advisable to talk about it with other family members. “Unequal treatment between siblings is always difficult. That’s why you should never hide a private loan, but rather disclose all agreements about it,” advises lawyer Bergdolt.

Unlike a bank, relatives or friends do not have to charge interest on money they borrow. Many people certainly rely on this when they pump up those around them. But that can backfire. If there is no or very low interest, the tax office can interpret a private loan as a gift. This is not a problem as long as the allowance is adhered to. For children this is 400,000 euros within ten years; grandchildren can receive 200,000 euros. Friends and distant relatives, on the other hand, only have an allowance of 20,000 euros. If the amount is above this, gift tax may apply.

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

However, the interest income is spared if the lender has not yet exhausted its savings allowance of 1,000 euros. Anyone who borrows money and pays interest on it can save taxes 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 you back. Things can still go wrong. “In an emergency, you have to sue – even against relatives or friends. You have a better chance if there is a contract for the loan,” explains Bergdolt. However, she recommends that if there are disputes in your close environment, you should first try mediation out of court. If the repayment fails, the lender is often left with the loss. If there is no money to pay off the loan, nothing can be seized. After all, if the loan is definitely not repaid, the lender can offset its loss against other capital income and thus save taxes.

Editor’s note: This article first appeared on “Capital”.