Family loans

If you need an extra few thousand dollars to make a down payment or to purchase a house, or are facing tuition fees or a car purchase, borrowing from a family member may be a good option. Thousands of Americans go this route every year. In fact, the peer-to-peer loan market, including private mortgages, is $65 billion annually. If you’re thinking of borrowing from or lending to someone near and dear, think through the impact it will have on your relationship first. Be sure to put key terms of the loan in writing and consider getting professional advice if the amount of the loan is substantial.

Family loans are tempting for several reasons:

  • they usually require less security, or none at all
  • the interest is often lower, or non-existent
  • the terms are more flexible
  • the lender is less likely to require a detailed business plan

If you’re the borrower
It’s convenient to get a family loan. But, if things go sour, relationships can suffer. Even though the Bank of Mom and Dad is the lender, you should treat the loan just as seriously as if it were an arm’s-length transaction.

If you’re the lender
You need to avoid putting your own financial future at risk. As a general rule, don’t lend more than you can afford to lose -- there’s always the possibility you won’t be paid back. It’s OK to say no. Refusing a family member’s request for money now won’t be as painful as dealing with payment problems in the future.

Take an interest
There are tax implications for certain person-to-person loans. As always, you should check with a tax consultant to determine the requirements in your situation. However, as a general rule, there are no tax implications for either party for loans under $10,000. But you may be required to charge interest on loans of more than $10,000. And with interest-bearing loans -- even if the rate is very low -- the lender must declare the interest as taxable income. If the borrower is using the money for business purposes, he can generally deduct the interest when calculating profit.

Get it in writing
For smaller loans, you may not need a formal legal agreement, but you should put the key terms of the loan in writing. These include:

  • a repayment schedule, including dates, amounts and interest (spreadsheet programs such as Excel include templates that make this easy)
  • a description of how the money will be used
  • some explanation of how problems will be resolved if they arise

In a dispute, these documents protect both parties from any attempt to misrepresent the original terms. And if the borrower is unable to repay the debt, the paperwork will help the lender write it off as a non-business bad debt for income-tax purposes. For best results, retain a qualified attorney to represent your interests.

Talk to an expert
If the loan is substantial, or if it’s going to be used for a risky business venture, it’s a good idea to seek the advice of a lawyer or accountant. This will help both parties consider key issues objectively and reach a decision everyone is comfortable with. To save on fees, you may want to prepare a draft agreement yourself and simply ask a professional to review it. 

For smaller loans, you may not need a formal legal agreement, but you should put the key terms of the loan in writing. These include:

  • a repayment schedule, including dates, amounts and interest (spreadsheet programs such as Excel include templates that make this easy)
  • a description of how the money will be used
  • some explanation of how problems will be resolved if they arise

In a dispute, these documents protect both parties from any attempt to misrepresent the original terms. And if the borrower is unable to repay the debt, the paperwork will help the lender write it off as a non-business bad debt for income-tax purposes. For best results, retain a qualified attorney to represent your interests. 

 

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