Family Lending

Times are tough, which means more individuals will find themselves requesting financial help from a family member. Before you consider writing a check for a family bailout, take steps to help protect yourself and your relationships. The more you can do to clarify your agreement and establish guidelines for repayment, the better off you both will be.

Know the risks of intra-family lending

Family loans can put relationships at risk by creating an imbalance of power. The lender can feel unfairly treated if the borrower fails to repay or appears to lead an extravagant lifestyle. The borrower may resent the demands of a repayment schedule and the extra financial scrutiny that is tacked onto a family loan. Both parties need to be aware that borrowed money can quickly become the elephant in the room, creating rifts in families.

Put it in writing

If you decide to go through with a family loan, as the lender, it’s up to you to determine the terms of the arrangement. Both sides benefit when a signed written contract is established. As the lender, you should create a schedule of monthly payments and the level of interest, if any, that is applied to the principal. That way, the borrower understands your expectations for repayment and you have something to point to if the terms are not met.

Consider a third-party middleman

You don’t have to go it alone. There are companies out there that administer family loans for a fee. With this kind of arrangement, you determine whatever interest rate you’d like to charge, but the borrower will also be required to pay the administrative loan fees, which can add up rather quickly. You may consider this a small price to pay for the reassurance that your private loan is repaid through monthly payments that are conveniently and automatically deducted from a checking account. Third-party loan administration beats having to drop hints about a late payment at the next family gathering. If the amount being loaned is significant and you want an airtight agreement, consult a lawyer to draw up paperwork—but prepare yourself for an uphill emotional and legal battle if your beloved borrower defaults.

Avoid tax problems

If you keep your loan under $10,000, the IRS won’t meddle in your family loan. But once the dollar amount exceeds this threshold, your family loan is a public matter that is subject to income tax. As the lender, you will be required to report earned interest as taxable income. If the borrower defaults on the loan, he or she may be responsible for income taxes on the balance. Talk to a tax specialist and determine your tax obligation to help avoid trouble.

Only lend what you can afford to lose

Even if your family loan has been drawn up with legal paperwork, it can be difficult to follow through on agreed-upon default procedures when family is at stake. Therefore, lend only what you can reasonably afford to lose. Still, you should do what you can to require repayment by outlining your expectations if payments stop or other trouble arises.

Get advice from a neutral financial expert

A financial advisor can help you determine whether you can afford to extend a loan to a family member with no guarantee of repayment. A financial advisor is also a great resource to help borrowers gain better control of their spending and avoid the problems that put them in their dire situation in the first place.

AJ Jugan and Brian Stumpf are financial advisors and Certified Financial Planner™ professionals. Andrew (AJ) can be reached by calling 412-635-5813 or emailing andrew.m.jugan@ampf.com. Brian can be reached by calling 724-799-2782 or emailing brian.d.stumpf@ampf.com.