It depends on the amount of the loan. If the loan is under $10,000, you are not required to charge interest. However, if the loan is for more than $10,000, you need to charge an interest rate that is at least equal to the applicable federal rate, or AFR, determined by the IRS. The AFR varies according to several factors, including the length of the loan -- short-term, mid-term or long-term -- as well as the repayment schedule -- annually, semi-annually, quarterly or monthly. For example, the AFR for a short-term loan repaid in monthly installments is 4.30 percent for February 2006.
If you decide to charge your friend an interest rate that is lower than the AFR, the difference between this interest rate and the AFR is considered a gift. So, if the AFR for a loan between you and your friend is 4.30 percent and you decide to charge only 2.30 percent, the 2 percent difference is considered a gift to your friend.
In order to avoid a gift tax, the amount of the gifted interest cannot exceed $12,000 in 2006. Keep in mind that as a lender you will need to report the 2 percent difference as income on your federal income tax return. Also, in addition to the federal rules on lending, you should investigate your home state's rules to make sure the terms of your loan comply.
How can you tell your friend no?
If you are financially unable or just too uncomfortable to lend money to a friend, it is important to be honest. If you lend money to someone who does not have the ability to pay you back, it would be far worse to hound your friend for the money than it would be to say no from the start. Although you may say no to the loan, you could offer to help your friend explore other options for getting the money. In addition, you might want to help your friend figure out his or her current expenses to determine ways to cut back to find the money within his or her own income.
How do you handle jealousy issues about money between friends?
Some of your oldest friends may date back to college and earlier -- a time when salaries were nonexistent or minimal. As you move into the work force though, one friend's salary may soon exceed another's by a small or significant amount, inevitably leading to envy. Whether you are envied or green with envy, it is important to make peace with your own situation.
If you are falling behind your friends in your finances, you may end up questioning your life decisions or resenting them for having the means to do more in life. However, if you let these feelings get the better of you, they will eat away at your friendships. You need to avoid comparisons and instead focus on what you have in common. Similarly, if you find yourself as the object of envy, appreciate your good fortune. But at the same time, do not throw it in your friend's face. Emphasize that you do not want money to come between you, and be cognizant of your friend's financial constraints when planning get-togethers.
Mellody Hobson, president of Ariel Capital Management (arielmutualfunds.com) in Chicago, is ABC News' personal finance expert. Matthew Yale and Aimee Z. Daley contributed to this report.