Borrowing or lending a loan from a family member might always sound like a good and safe idea. You know; the borrower will definitely get an easy approval. Plus, any interests that the borrower pays stays within the family. Family loans are usually successful. But that success can only come with a lot of planning and open communication.
Family loans require both the lender and the borrower to be ready to handle both the administrative and emotional affairs for the loan to be a success. To ensure that you do it right, you need to ensure that you focus on these key areas:
- Don’t get into any trouble with the IRS
- Protect your relationship
- Protect the lender financially
You will also need to navigate through any legal pitfalls such as the usury laws or any abusive debt collection practices. Most family members, however, are not loan sharks, meaning that issues like these are always less common. Borrowers fall victims to banks, creditors, and other lenders who are more prone to such practices. But this article aims to give you valuable insight on some crucial facts about family loans that you might be interested in.
- What is a family loan?
This is a loan between the lender and borrower who are also family members. This loan doesn’t use the bank, online lender, or any credit union. It doesn’t matter what the borrower plans to use the money for.
The intention of these loans is always to end the situation as a win/win – a good deal for the lender and the borrower alike. And the main purpose for this is to keep the family intact. As long as both the lender and the borrower of the loan stick to the agreement, then everything should run smoothly.
A family loan generally occurs when the lender is willing and ready to help the person he/she loves. And this is always a good start – a sign of good will. But there are other ways with which the lender can help an aggrieved family member too. Other financial forms of assistance like gifting and cosigning on a loan can also help.
- Protecting the relationship
Ensure you, both the lender and the borrower, discuss the loan in detail. And it is either the lender or the borrower is married, then it is best to inform and include the other partners in the decisions as well. When it comes to family loans, there is no such thing as the borrower or lender being too detailed. It is safe to assume that the other family members also know what you are going through. Be open to one another especially when it touches on finances.
- Protect the lender
Remember, in a family loan, it is the lender who is taking all the risks. Money that is kept in an FDIC insured account is generally more secure than a loan lent to a family member. You may have invested your money in a family member knowing that he/she is going to pay on the agreed dates. But you never really know what the future holds. What if the family member you lent the money to is involved in a fatal car accident? Your chances of getting the money back will simply start diminishing. It is for that reason that you need to make a family loan as formal as possible. Especially if it involves large sums of money. Have a local attorney involved, have collateral, and a written and signed agreement between you (the lender) and the borrower.
- Tax laws
The IRS basically has its teeth in everything, even the family loans between family members. So, ensure that you check with your local tax advisor before you sign any agreements or make a loan. Lenders of family loans can also put a low-interest rate on these loans. If you charge too little, however, the IRS will view the interest that was to be paid as a gift.
It is for such reasons that you must ensure that you have a written and signed document especially when the family loan involves huge amounts of money.
- Loan services
Handling any type of loan is always complicated. It is for this reason that many online services offering quick loans have come up to make the process easier. These services will:
- Report any activities to the credit bureaus
- Handle the logistics of repayments
- Provide documents that are tailored to your loan situation
- Provide tax documents where applicable