Family Loans: How to Approach Lending Money to Family
Borrowing money from family may sound like a no-brainer. You could save serious money on interest with a family loan, and the stakes might feel lower when you borrow from a person you know rather than a corporation.
But family loans do come with risks. If you can’t make payments, you could lose the relationship instead of points on your credit score. You’ll also need to consider tax implications and IRS guidelines to legally lend to or borrow from family.
What is a family loan?
A family loan is money one family member lends to another with the expectation of repayment. You and your family member can work together to come up with unique terms that work for both parties and consider each person’s particular financial situation.
That said, you must follow federal law when it comes to loans of $10,000 or more, and you should create a basic loan agreement regardless of loan size to protect both parties.
Family loan rates and tax implications
When the loan is less than $10,000, you have a lot of leeway in terms of rates and repayment terms. In fact, you can loan money to a family member without charging any interest as long as the loan is less than $10,000.
When the loan is $10,000 or more, the IRS requires that you charge a minimum interest rate called the applicable federal rate (AFR). The IRS sets these rates on a monthly basis, and they’re typically much lower than the rates that you’ll get with traditional lenders. The family member who is lending money will also need to pay income tax on the interest.
Pros and cons of family loans
| Pros | Cons |
|---|---|
Low interest rates. You can save money on interest with low rates on a family loan. Some family members may be willing to offer loans without charging interest. Easy to get. You won’t have to worry about whether you’ll qualify for a family loan, and you’ll skip the application process. Custom terms. You and your family member have a lot of flexibility when it comes to naming loan terms and rates, though you’ll still need to abide by IRS rules. | Risk damaging relationship. If you’re not able to pay back your loan because of a crisis like an emergency expense or a sudden layoff, you can put a strain on your loved one’s finances — and your relationship. Tax implications. If you borrow more than $10,000, your family member will need to charge a minimum interest rate on the loan and pay income taxes on the interest payments. Don’t build credit. Your family member won’t be reporting your payments to the credit bureaus, so you’ll be giving up the credit boost you’ll get with on-time loan payments. |
Writing a family loan agreement
Having a loan agreement in place will ensure that both parties are on the same page about the exact loan terms and consequences if the borrower isn’t able to make payments on time.
Your loan contract should be written and signed by both parties, and we recommend that you get it notarized or signed by a witness.
Your family loan agreement should include the loan amount, method of payment, when payments will be made and what will happen if you pay off the debt early, miss payments or stop paying entirely.
You can find family loan templates online on sites like TemplateLab and Legal Templates.
As you draw up your loan contracts, use our personal loan calculator to estimate your monthly payment and calculate the total amount you’ll pay in interest.
Family loan alternatives
Loaning money to family isn’t for everyone, and it comes with risk to your relationships and finances. Whether you’re the potential lender or recipient, considering the following alternatives may help you avoid future tax implications and strained communication with your loved one.
Gifting
If you can afford it and don’t want to risk the relationship, consider giving your family member the money they need rather than offering a loan. You’ll avoid potential tension and conflict, and you won’t have to deal with the hassle of drafting a formal loan agreement or potentially paying income tax on any interest the family loan incurs.
But you’ll still need to play by IRS rules if you choose to gift the money. As of 2024, you can give up to $18,000 to a person in a year without having to report it to the IRS and potentially incurring a gift tax. There is a lifetime gift tax exemption of $13,610,000. You’ll need to pay a gift tax on any money you give to one person that exceeds that amount.
Personal loans
Getting a personal loan can help you build credit and avoid tension and complex tax implications that often come with family loans. Whether you’re worried about meeting personal loan requirements or you need fast cash, there’s likely a personal loan designed for your unique financial situation.
Here are some personal loan alternatives to family loans, along with their benefits.
| Loan type | Benefit | What is it? |
|---|---|---|
| Secured loan | Easier to qualify for | A loan guaranteed by collateral like physical property or a savings account |
| Credit-builder loan | Build credit | A loan designed to help borrowers with thin or no credit history build credit |
| Bad-credit loan | Designed for borrowers with bad credit | A loan with low eligibility requirements that doesn’t charge predatory rates |
| Quick loan | Fast funding | A loan that offers quick — often same-day — access to cash |
Cosigning
If you have good or excellent credit, cosigning a loan can help your loved one access the money they need at potentially lower rates than they’d qualify for on their own. Having a third–party facilitate the loan can minimize some of the stress, tension and paperwork associated with mixing family and finances.
But if your family member defaults on the loan, you’ll be on the hook to pay it off, and a loan in default (or any missed payments, for that matter) can impact your credit.