Borrowing money from a close friend or family member can be your quickest and easiest option when you need money urgently. After all, who better to help you in difficult times than those who care most about you?
However, money has the power to strengthen or strain relationships. So, make sure you approach this matter with a clear plan and ultimate care. This article will explain how.
KEY TAKEAWAYS
- A family loan is a good solution for emergencies if handled with transparency.
- Having a written loan agreement helps make sure everyone is on the same page.
- Lending or borrowing a family loan can risk jeopardizing your relationship.
Understanding Family Loans
A family loan is a private agreement where a family member lends money to another with the expectation of repayment. This process doesn’t involve any financial institutions or banks. It is based on trust rather than credit score.
But this doesn’t mean you should skip the paperwork. No matter if you’re borrowing or loaning money to family, consider treating the process as professionally as possible. This helps avoid putting your relationship at risk. Without a written agreement, spoken promises can lead to misunderstandings.
I know involving paperwork may feel weird, as it can indicate a lack of trust. But you don’t want to risk breaking ties because of money, do you? Both parties have to realize that this is for their mutual benefit.
What Can a Family Loan Be Used For?
The most common reasons why family members ask for a loan are:
- To cover unexpected expenses like medical expenses, home repairs, or car repairs
- To buy a house or pay the downpayment for a mortgage
- To start their own business
Do’s and Don’ts of Lending to Friends and Family
If you’re considering lending money to friends and family, the table below can help you get through this sensitive situation you’re in.
| Do’s | Don’ts |
| Put everything in writing by creating a solid family loan agreement | Don’t rely on verbal promises |
| Communicate about expectations, plans, and potential changes with 100% transparency | Don’t let your emotions influence your decision |
| Set clear terms and payment deadlines | Don’t be shy about your needs and expectations |
| Consider including a small interest rate | Don’t assume the loan will be repaid on time |
| Think about how it will impact your relationship and long-term family financial planning | Don’t expect favors or control in return |
| Discuss what will happen if they fail to repay | Don’t lend money that you can’t afford to lose |
How to Make a Family Loan Agreement
A family loan agreement can be more than just a verbal promise sealed by a handshake. Having tangible proof can strengthen your case you need to take legal action. That’s why when loaning money to friends and family, confirm your promises with a written loan contract. The document should include a set of clear terms agreed upon by both parties to avoid conflict.
What to Include in a Family Loan Agreement
Your loan contract should include:
- The borrower’s and the lender’s names
- The date the loan was granted
- The loan amount
- The repayment schedule
- The minimum monthly payment
- The interest rate
- Consequences for defaulting on the loan
Please note that we offer this for informational purposes only. Please consult with an attorney for the most accurate information about preparing a family loan agreement.
Pros and Cons of Family Loans
Before involving a family member in your finances, consider weighing the benefits and potential drawbacks of borrowing or lending money.
Pros
- Family loans are more affordable, often carrying low to zero interest rates
- You can negotiate flexible terms, which is very hard to do with a traditional loan
- Borrowing or lending to someone whom you know and trust can make the process less stressful
- It is also more convenient to borrow from a family member than a financial institution
- Your credit score will not get hit because family loans don’t require credit checks
Cons
- Money can complicate relationships and create problems, especially when the borrower is not able to repay the loan
- Assuming there is no written loan agreement, a handshake loan or a verbal agreement will be harder to prove in court if it ever comes to that
- Getting a family loan doesn’t help build credit, as your payments are not reported to the credit bureaus
Alternatives to Family Loans
If a family loan doesn’t seem like an option for you, consider these alternatives.
First, you can consider getting a personal loan from a bank or credit union. How much you’ll pay in interest can vary depending on your credit score and history. But you can expect to pay anywhere from 5% to 35.99% APR and pay it back in up to seven years.
If you need money to afford a down payment on your home, you could consider borrowing from your 401(k) retirement fund. You can borrow the lesser of 50% or $50,000 of your vested account balance.
If you already have a home and enough equity, you can consider getting a home equity loan or home equity line of credit (HELOC). The interest rates range around 3% to 7%, and you can pay back the loan in up to 15 years.
If the reason why you want a family loan is to start your own business, then consider getting an SBA (small business administration) loan. They offer different loan programs leading up to $5 million. The loan term can range up to 25 years.
If you need money to cover unexpected medical expenses, there are different government programs you can apply to, like Medicare, Medicaid, and CHIP (Children’s Health Insurance Program). These programs are need-based with eligibility restrictions.
If you need help to pay for utilities or rent, you can apply to LIHEAP (Low Income Home Energy Assistance Program) and ERAP (Emergency Rental Assistance Program).
You can also consider setting up a crowdfunding campaign on platforms like GoFundMe to raise money for whatever you’re going through. Be transparent and explain your situation to show that you genuinely need their help.
Understanding how to borrow money from family or friends is a decision that cannot be taken lightly. While family loans might offer fast relief, they come with risks that can affect your relationship for a lifetime. So, before you promise anything, take the time to plan and consider all the potential outcomes and alternatives. This way, you can make the right decision.
FAQs About Family Loans
The following are answers to common questions.
What Is the Disadvantage of Getting a Loan from Friends or Family Members?
The main disadvantage of getting a family loan is the risk of damaging your relationship with a valuable family member. If the borrower struggles to pay back, this can develop hard feelings of resentment, or, worse, estrangement.
How Do You Legally Loan Money to a Family Member?
To legally loan money to a family member, you need a family loan agreement or a promissory note. This document should outline your name, the loan amount, repayment terms, interest rate if applicable, and the consequences in case of default. Both parties should sign the document to make it official, and it can be legally enforced in court.
What Considerations Would You Make When Deciding Whether or Not to Loan Them the Money?
The first thing you need to consider is whether you can afford to lose the money you’re lending in case they don’t repay the loan. Second, consider whether the borrower has the means to repay the loan. Finally, consider how the loan might affect your relationship with the borrower.
Can You Charge Interest on a Family Loan?
Yes. If both parties agree, you can charge interest on a family loan. But remember, you need to report it as income to the IRS and follow their interest rate guidelines.
What Are the Tax Implications of a Family Loan?
If you’re lending over $17,000 with no interest, you need to file a gift tax return. If you want to charge interest, you must follow the IRS interest rates guidelines and report it as income.
Please note that the IRS can impute interest on interest-free loans over $10,000. People lending money may need to report this imputed interest as income, even if they did not receive it.
Is It Better To Borrow Money From Family or Take a Personal Loan?
It depends on the situation you’re in. A family loan can be quicker with zero to low interest rates, flexible terms, and no credit check. However, you may risk jeopardizing your relationship if you don’t make timely payments.
On the other hand, a personal loan may take longer to get and require a credit check and additional documents. You may also get a larger amount but pay more interest without risking your relationship with your family.