Should You Take Legal Action if a Friend Borrowed Money and Won’t Return It?

Rachel Curry

Rachel Curry

Published on: 26 April, 2022

Law Gavel

For many, lending money is a no-brainer 🧠… until you can’t get your money back. But don’t worry—if you lend someone money and they don’t pay you back, you have options. Here’s when to take legal action and how to go about it, including how to begin navigating the court system if necessary.

What we’ll cover:

  • What is the legal definition of debt?
  • When to take legal action on an unpaid loan
  • Types of courts and when to use them

Legal definition of debt, and how it applies to personal loans

There are certain aspects that must be in place for a loan to be considered legally unpaid. It’s best to think of debt as having two key parts: The principal (aka the base amount of the loan) and the interest (the cost of borrowing money).

In the US, debtor and creditor laws apply to both institutional loans and family/personal loans. Both lenders and borrowers are protected by these laws.

To determine if a personal loan you made to a friend or family member is legally unpaid, ask yourself:

  • Were the terms of the loan clearly stated and agreed to?
  • Has the deadline for an installment or final payment passed? 
  • Has the borrower failed to pay the total amount, including the loan’s principal and interest?
  • Is the borrower unwilling or unable to pay?

If the person you loaned money to is financially unable to pay and can prove it (whether through bankruptcy or a record of other financial problems), you may be able to write the unpaid debt off as an expense on your taxes. According to the Internal Revenue Service (IRS), this is called a bad debt deduction. If they can pay but aren’t doing so, that could be grounds for a lawsuit.

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If you can’t resolve the loan dispute on your own, consider legal action

In an ideal situation, you and the loved one borrowing money from you can resolve the issue on your own. Most people don’t want to go to court, especially when it involves going against people who are close to you. 😅

Unfortunately, that’s not a reality for everyone. When clear, consistent payment reminders and communication don’t work, lenders may consider legal action to collect an unpaid loan. Seek legal advice before proceeding with any legal action.

Do you have your loan agreement in writing?

Before doing anything else, check if you have a written loan agreement. When signed, a loan contract or promissory note is the backbone of a loan dispute. Ideally, you’ll have documents that clearly state the loan principal, interest rate, payment due dates, and any other crucial info.

Pro tip: When you make a loan, charge at least a little bit of interest! This helps prove your loan was not a gift, which could be subject to gift tax. 🎁

What if you have no loan agreement? Your legal options

Maybe you’re here because you didn’t have the borrower sign a loan agreement. A loan contract is a type of digital or physical record of the loan that you and the borrower agreed to. It’s the sturdiest form of proof showcasing the loan terms and the buyer’s agreement to repay.

Additionally, you can refer to money transfer or bank account transfer records to show evidence that the loan was given. However, you’ll need additional evidence to prove it was a loan, not a gift or some sort of bartering arrangement.

Still planning for a future loan? Use Pigeon Loans 🐣 to keep your loan document secure. If you’re shy about sending gentle reminders to someone you know, we’ll automate it for you based on your payment deadlines.

Court House

Types of courts and how to use them for loan repayment 

Your avenue for legal action will look different depending on the size and type of loan.

Suing in small claims court

Small claims courts handle disputes worth $25,000 or less depending on the state you live in. That means the total amount of money someone owes on your loan—including principal and interest—must not exceed this amount.

You don’t need an attorney to sue in small claims court. If the total loan amount of your loan is above the limit, you may be able to divide it into parts and only sue on the unpaid balance.

Unpaid loans between close friends and family are one of the most common cases in small claims court. Financial institutions like banks cannot sue in small claims court. If you’re considering whether or not it is worth going to small claims court, reach out to the court in the county your loan contract stipulates.

When and how to sue in state civil court

To sue someone for a higher balance (for example, more than $25,000), you can look to state civil court (again, in the state your agreement outlines).

In this case, you’ll typically get an attorney and serve the debtor with a lawsuit notice. Make sure you follow the Fair Debt Collection Practices Act, which governs how you can go about collecting debts. For example, you cannot engage in harassment or violence of any kind. 🙅🏽‍♀️

State civil cases can occur through mediation or trial. Courts push mediation because it’s cheaper and easier for everyone involved. However, if it goes to trial, you may need to present evidence in your small claims court case.

Federal court for special circumstances

Federal court is reserved for special circumstances. If your lawsuit takes place over multiple states, you may be able to get a “diversity of citizenship” case. If there are multiple plaintiffs and/or defendants, no two people can live in the same state. 🗺️

A personal loan dispute usually answers to state law. However, federal courts may see diversity of citizenship cases if the unpaid loan balance is more than $75,000.

Bottom line

There are ways to make the loan process go smoothly for lenders, like signing a loan contract in advance with clearly stated repayment terms. Still, hiccups can occur when you lend a friend money.

Know your options in small claims, state civil, and even federal court. If you still have the chance, put a written agreement in place between you and the borrower ahead of time.

Pigeon Loans is the perfect solution for personal loan situations. Negotiate your repayment plan and build a loan contract with the borrower right on the platform—and we’ll send the payment reminders for you. Create your loan agreement now. 👋

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