Should you charge interest when you lend to a friend?
Most loans between friends are interest-free, and that’s usually the right call. But for a large amount, or a loan that runs for years, a small rate can make the deal fairer for both of you. Here’s how to decide, and how to work it out.
When interest makes sense
- The amount is large, and the money would otherwise be earning interest in your savings.
- The loan runs for a long time: a year or more, not until payday.
- It’s for a business or an investment that should pay for itself.
- The borrower prefers it. Some people find it easier to borrow on fair terms than to accept a favour.
Skip it for small amounts, short loans and emergencies. Charging interest to someone in a crisis rarely feels good on either side.
Picking a fair rate
A simple rule: choose a rate between what your savings earn and what a bank would charge your friend. If your savings earn 3% a year and a personal loan from a bank would cost them 11%, anything in between leaves you both better off than going elsewhere. Many people settle near the middle.
Simple or compound interest
Simple interest is charged only on the amount you lent. Compound interest is also charged on interest that has already built up, so it grows a little faster. For $1,000 lent for two years at 5% a year:
| Method | Interest after 2 years | Total to repay |
|---|---|---|
| Simple | $100.00 | $1,100.00 |
| Compounded yearly | $102.50 | $1,102.50 |
| Compounded monthly | $104.94 | $1,104.94 |
For short, informal loans the difference is small, and simple interest is much easier to check. Try your own numbers in the interest calculator.
When there are repayments along the way
If the loan is repaid in parts, interest is usually charged only on what’s still owed, so each repayment lowers the interest that follows. A fixed monthly payment handles this for you: early payments are mostly interest, later ones mostly the loan itself. See how a loan’s monthly payment is calculated.
Put the terms in writing
Write down the rate, whether it’s simple or compound, when interest starts, and what happens if a payment is late. An IOU or a short loan agreement is enough. Agreeing interest afterwards almost always turns into an argument.
Check the rules where you live
Many countries cap interest rates, interest you receive is often taxable, and some tax systems treat large interest-free loans between family members as gifts. If the amount is significant, check locally or ask an accountant. This guide is general information, not legal or tax advice.
In ClearOwe, Pro adds interest to a loan, simple or compound, at the rate you agreed, so the balance you see is what’s owed today.
Common questions
Is it legal to charge a friend interest?
In most places, yes, as long as the rate is reasonable. Many countries cap interest rates, and some have rules for lending as a business. If you’re charging interest on a large amount, check your local rules.
What’s a fair interest rate for a personal loan to a friend?
Many people pick a rate between what the lender would earn in a savings account and what the borrower would pay a bank. That way both of you come out ahead of the alternative.
Do I pay tax on interest a friend pays me?
In many countries, interest you receive counts as taxable income, even from a friend. Keep a record of what you received and check your local rules.
Simple or compound interest for a personal loan?
Simple interest is easier to understand and to check, which is why most informal loans use it. Compound interest is more common for longer loans, and should be agreed in writing.