Offering interest-free loans is a mitzva. The purpose of the mitzva is to enable people to meet their basic expenses when they have temporary financial difficulty. Therefore, a borrower may not use a loan to buy luxury items unless the lender has agreed to this.
Lenders must document their loans, in order to avoid later unpleasantness about the amount or terms of the loan. The only person who is permitted to give an undocumented loan is someone who is ready to forgive a debt wholeheartedly if the borrower forgets about it.
Sometimes borrowers are unable to repay a loan. In such cases, it is forbidden to make their lives miserable, forcing them to go into debt or sell necessities in order to return the money. Thus we read, “Do not be like a moneylender” (Exodus 22:24). However, when it is known that a prospective borrower is irresponsible and there is a reasonable chance the borrower will not repay the loan, there is no mitzva to lend them money, since the mitzva to lend is meant to help responsible people who will make every effort to repay the loan.