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Apr-17-2019 14:21printcomments

How to Take a Loan from Family without Risk to Lender or Borrower

Be wary, money often does not mix well with close friends & family.

Photo: Alexander Mils, Pexels

(SALEM Ore.) - It is your sister Christie's big day, and the dark teal tulle off shoulder gown you are in is a sight. All is perfect except for the discomfort and anxiety you are experiencing at the thought of talking to your cousin Shirley. Yes, Shirley who you graciously loaned $700 to, which now you badly need to fix your laptop's screen.

She was in dire financial need, and you lent it to her for a month. Well, Shirley took the money, went mum and stopped responding to your texts and lately your calls too. Should you not have come to her aid and spared yourself this torment?

Meaning of a family loan

Also known as an intrafamily loan, a credit between members of a family is informal and often times have no contracts. These loans work very well for family dynamics where members just want to give each other a helping hand. Where simple agreements have been made, the loans acquire tax obligations and interest earned from the investment has to be taxed.

Money and family bonds

Did you know that friends and family give away over $89 billion in loans annually in the U.S? The bank of family is the most popular source of business funding for startups or for a home purchase. Over 38% of all new businesses rely on startup funds from family while 6% of home buyers use funds sourced from family.

Family is always a good place to go for financial assistance when all other doors have been shut in your face. A CNBC report shows that most persons of color and those with low income choose to borrow cash from their family rather than max out their credit cards. Bank of family has its unique advantages over conventional bank loans.

While the interest rate of plastic cash can hit 17.67%, family members will definitely ask for less. If necessary, you can also happily haggle over these rates, unlike the strict settings that bank halls and managers provide. As affordable as these loans are, however, they have very risky both for the borrower and lender.

If the loaning process is guided by emotion, it could eventually hurt your relationship, a tie that is probably worth more than money.

Money does not mix well with most close ties and family relationships especially can get muddled pretty fast by money. In the illustration, over 57% respondents in a survey agree that they had witnessed close family ties get ruined when a party loaned the other some cash, and the loaned party failed to pay them back as agreed.

It is therefore advisable that if a family member asks for a loan from you, that you take the time to deliberate on your decision first.

So how do you become the family piggy bank and yet preserve all your relationships with your lender?

How to protect the lender

Make an agreement
Lend only what you are willing to lose if you are lending to relatives and you are not going to get into a clear understanding with them. Lending to the family is usually a bad investment since you cannot report them to a credit bureau. But the action of nonpayment could burn bridges between family members, causing disharmony and conflict.

Alternatively, make it very clear that what you are lending to them is a loan and not a gift. Let the borrowing party prove that they have the cash flow required to repay the loan over the agreed time.

Make the agreement official
Do not make verbal agreements if you want to preserve your relationships. Write down a payment agreement, highlighting the amount borrowed, and the agreed repayment schedule. Mention the interest rate too, because the payments will be taxed as they are deposited to your account.

Ask for collateral
Since the lender is taking a risk, they can ask the borrower for guarantee to secure the loan. This could be an asset such as car or electronics that can be sold off if the repayment agreement goes south. This is method is challenging to enforce between family members unless both teams are very open-minded and understanding.

Seek legal guidance
Talk to an attorney and go through all the risks associated with the loan. Discuss options if any of protecting yourself so that you can cover yourself and your dependents as well.

Talk to a tax advisor
There are tax laws that affect loans to a family so ask your local tax person about your IRS obligations. The tax man allows you to charge low-interest rates. However, if you charge too little, you will be liable for gift taxes. Check on the Federal Rates that apply to your loan and talk to your tax adviser before settling on an interest rate for the loan.

Loan services
The process of streamlining a loan process with family members can be complicated. If you have a hard time making it official and legal seek the help of online services.

They, for example, will solve all the logistic issues involving an automatic transfer of the payment deposits from the borrowers account to yours. They will also provide personalized documentation for your loan, tax documents and they will undertake the reporting of any activity to credit bureaus.

Advantages of family loans

  • You do not need credit checks to loan each other money
  • Family type loans often have lower interest than bank loans
  • The interest paid on the loan by the borrower assists a family member rather than an institution

Disadvantages of family loans

  • They can ruin family dynamics and cause family tension, breaking family bonds
  • A repaid family loan may not positively impact your credit score unless active reporting was done to credit bureaus
  • There are tax obligations that accrue to family loans. There are interest rates that apply too.
  • The paperwork required may be too complicated for most family members. There is also a need to track interest, follow up on repayments and promissory notes to write which can be hampered by family bonds.

The final word

The win-win situation created between both lender and a borrower makes the bank of family a perfect source of credit for families with strong bonds. This is also its most significant disadvantage.

Strong relationships are worth more than money, and they can easily get eroded if the loan was given irresponsibly. Such a situation can destroy partnerships and bonds built over the years breaking communication lines.

However if communication is restored even the worst of lending situations can be fixed, but to avoid these situations borrow or lend money to family members responsibly.

Source: Special Features Dept.


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