Saving Tips

Family Loans: What to Know Before Lending or Borrowing

Family Loans: What to Know Before Lending or Borrowing
Reviewed by Melissa Cook
Updated November 6, 2022

Some say you should never lend money to a family member. However, when a family loan situation is approached carefully and thoughtfully, it can be a beneficial solution for getting money to a family member who needs it.

What is a family loan?

A family loan occurs when a family member lends money to another family member. Family loans can be appealing because they often have lower interest rates and more flexible terms than traditional loans from banks or lenders. There is also the added benefit of a personal connection and trust in the lender. Family loans can be useful for covering unexpected expenses or helping with large purchases.

What to consider before you get or lend a family loan

A family loan can be a helpful solution for obtaining funds, but it is crucial to approach the situation thoughtfully and carefully. Before entering into a family loan agreement, some things to consider include:

  • Consult with a financial professional or lawyer

A financial professional or lawyer can provide valuable insight and guidance on your family loan’s potential legal or tax implications. They can also help establish a solid repayment plan and ensure that the loan agreement complies with applicable laws and regulations.

  1. Clearly communicate expectations and responsibilities.

Communication in a family loan is important because it sets clear expectations and helps to avoid misunderstandings or conflicts. It’s also important to outline responsibilities, establish a repayment plan, and consider any potential legal or tax implications.

  • Consider the potential impact on family relationships

Dynamic family relationships can impact a family loan. It is essential to consider how seriously the loan may affect dynamics within the family and to approach the situation with care. For instance, if one sibling lends money to another and sets strict terms or expects immediate repayment, it could create tension or resentment within the personal relationship. On the other hand, if a parent loans money to their child with no expectations or strict terms, it could lead to a sense of entitlement or dependency in the child.

  • Don’t forget about taxes

Taxes play an important role in family loans. The Internal Revenue Service (IRS) requires that any interest earned on a loan be reported as income by the lender and can be tax deductible for the borrower. It’s important to note that the IRS considers gifts of money above a certain amount to be taxable.

Examples of Family Loans

Family loans happen more than you might realize. According to a study by LegalZoom, about 40% of respondents have lent money to or borrowed from family or friends. The following are the most common examples of family loans:

  • College Funds

When a parent lends money to their child to help with the cost of college, it’s typically done through a family loan.

  • New Business

Parents will often loan their child money to help them start their own businesses.

  • Down Payments

A sibling may choose to lend money to their brother or sister to help with a down payment on a house.

  • Emergency Expenses

Family members may choose to lend money for unexpected medical or financial emergencies.

What are the pros and cons of family loans?

One benefit of choosing a family loan is that they offer a lower interest rate compared to traditional loans from a bank or financial institution. They also offer more flexible payment terms. Loved ones who lend support to a family member in need may also benefit from the investment later down the road.
The negative side of getting a family loan includes a risk to personal family relationships and the financial consequences of defaulting on the loan. Additionally, there may be tax implications or legal considerations that need to be taken into account.

Final thoughts

If you’re considering getting a loan from a family member, it is important to carefully weigh the potential consequences. Overall, a family loan can be a beneficial solution for getting money when you need it, but it is important to approach the situation thoughtfully and carefully. Keep reading and learn what is a promissory note.
Thinking about getting or lending a family loan? Talk to the financial experts at Credit9 first.