2020 was a difficult year for a vast number of Americans, but especially for those who lost their jobs or were forced into part-time work. As money grew tight, people looked everywhere for ready sources of cash to pay their bills. One source some turned to was family loans. But is it a good idea for either side? Here are some steps you can take if you choose to lend money to a family member.
Making a decision
It’s difficult to decide to loan money. You want to help your family member, but you feel weird having been put on the spot. It may cause stress or sleepless nights. Some questions to ask include:
- Is this person constantly struggling to pay bills because of spendthrift ways or are they having a one-time emergency?
- What’s the money to be used for?
- Have you loaned money before to this person, never to see it again?
- Have they helped you when you’ve needed it?
- Do they have a way to repay (current job, real prospects for a new job)?
- Are you willing to make it a gift if you’re not reimbursed?
- And finally, can you afford to loan the money?
Pros and Cons
Loans between family members can work out great and provide a source of needed income. The person receiving the loan can take advantage of lower interest rates with no credit check, and the person loaning money might be willing to allow a skipped payment or two if times get tight.
Loans between family members may also drive a wedge where sides are chosen and there’s a schism down the middle of the family. Even without family drama, your on-time loan repayments to your aunt won’t show up on your credit report. And some family lenders report that it seems to open a floodgate where other family members contact you needing money (you become the family bank). Only you know your family.
Put it in writing
If you decide to go forward, put it in writing. However, before you go through the process of creating a document, talk to the person about how you plan to approach the issue. Make sure they are comfortable with this becoming a business transaction. Some may miraculously find other sources of income if you are serious about expecting them to repay.
Once you’ve met and agreed to the terms, draw up a contract. No, you probably don’t need to go to a lawyer but finding a template online will make writing a contract easier. You should include how soon repayment starts, the payment schedule, what interest rate you’re charging, what happens if payments are late, and what collateral is being put up against the loan in case it’s not repaid at all. You may want to go into detail about what happens if either party passes away – is the loan erased?
Research IRS regulations
If you’re lending $100 to your brother to help him buy this week’s groceries, the IRS probably won’t care if you charge interest or not. However, if you lend $20,000 and don’t charge an appropriate rate of interest, the IRS could determine the loan was actually a gift or was income to the recipient. If you’re loaning a substantial amount of money, make sure you research IRS regulations and consider talking to a professional to stay on the right side of the law.
Expect to be at the bottom of the bill pile
Most people who go to family for loans don’t have a lot of options. This may be due to a poor credit rating, no credit rating, or no time to work through other loan alternatives. Chances are they have other bills, and knowing that their power could be turned off or their car repossessed could easily move your loan to the bottom of the pile. Don’t look the other way if you start noticing a trend of late payments.
Keep track of actual payments
This brings up another facet of treating this like a business transaction: the lender must keep up with payments, dates received, late fees, etc. It’s easy to deposit the checks and move on with your life. If your relative calls asking if they are paid in full, you need to be able to give them the correct answer. Create a spreadsheet detailing when and how much you were paid and how many payments are left before the loan is paid off. You can find samples online.
Neither a borrower…
Normally I don’t agree with Shakespeare’s statement “Neither a borrower nor a lender be.” I’ve used loans to my advantage throughout my life. However, when it comes to family, Will may be right. If it’s a small amount and you can afford it, consider just giving the money to your relative, no strings attached. Or possibly investigate co-signing a loan (but know that you are on the hook if they can’t make the payments).
Still your family
And don’t forget family dynamics. If you are lending the money and they are paying on time, don’t bring it up at the holidays (even if they pull up in a new car). If they aren’t paying, don’t go to their parents or children and bad mouth them. This is no one’s business but yours and theirs.
Lending within a family is a tough decision. I’ve faced it once and ended up just writing off the money as a gift. It wasn’t worth the hassle or headache of fighting about it. And fortunately it was small enough that I could just forget it. Make sure you are ok with whatever you decide before going forward.
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