Loans Among Family Members; Is It Worth It?

by Scott Sery on March 21, 2013

Personal LoansThere comes a time in most people’s lives where they need some money.  For many, they turn to the bank and apply for a loan.  There are times, however, when the banks are not the most desirable source of a loan.  Whether it is because of poor credit, undesirable interest rates, or a whole host of other situations, many people turn to their families for financial help.  While family can be a great financial backup, great care must be taken when lending and borrowing money within the family.

As the Borrower

If you are looking to your family as the source of your loan, you must approach the topic as though you were asking for a loan from the bank.  Make sure you have all your paperwork in order, and be transparent with the person you are requesting the loan from.  Before you even begin the subject of a loan be prepared to negotiate on the repayment plan, and be willing to pay the lender interest.  Most importantly, be willing to accept “no” for an answer without any grudges or hard feelings.

As the Lender

Despite your familial bond, your first obligation is to take care of your own financial needs.   Make sure whoever is requesting the loan has the means to repay it.  If they have been flaky in the past, do not assume they will suddenly change their ways.  Along those lines it may be tempting to just go with an oral contract of sorts.  Instead, for peace of mind of all involved, draw up some paperwork that has a written repayment plan in it.  The hardest part of loaning money to family members is the feeling of power that comes with it.  You will feel like they owe you, or are beneath you.  Nothing has changed with the relationship.  Finally, just like when investing, be prepared to lose your investment.  Never loan more than you cannot lose if it is not repaid.

There are some things to be aware of before making any sort of loan, to family or otherwise.  Most importantly is to make sure your loan is not viewed by the IRS as a gift.  The gift tax exclusion for 2013 is a $14,000 (per recipient) yearly exclusion and $5.25 million (per gifter).  If your loan falls under this amount, there shouldn’t be any problems.  However, if you are setting up a larger loan, you will want good documentation, perhaps drawn up by an attorney, to avoid any hassles with the IRS.

Along the lines of having proper paperwork in order is receiving interest payments.  Any interest you receive from a loan is considered taxable income to you.  Now you might be tempted to just charge 0% interest, but the IRS considers a no interest loan to be a gift rather than a loan.  While there are ways to get around charging interest with some fancy accounting, it is best to just remember you will most likely be on the hook for taxes paid on the interest.

Another important aspect of lending is what happens if the borrower dies.  If the loan is forgiven it can become taxable income to the borrower’s heirs.  There are many little nuances, so if the loan is large and the time period extends more than just a few years, make sure to have an attorney draft some loan paperwork for you.

When you are in tough times it might seem like reaching out to family is an easy solution.  Unfortunately, it can be a huge strain on the relationship.  And with tax laws the way they are, and all the implications that go into lending and borrowing, you might be better off just going with a bank loan if you are able.  If the loan is done correctly, however, it can help strengthen the bond between family members, and help the borrower to become more financially independent in the long run.

Have any of you taken a loan or borrowed money to a family member? How was your experience?

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Scott Sery

Scott Sery is a native to Billings, Montana. Within an hour in nearly any direction he can be found fishing, hunting, backpacking, caving, and rock or ice climbing. With an extensive knowledge of the finance and insurance world, Scott loves to write personal finance articles. When not talking money, he enjoys passing on his knowledge of the back country, or how to live sustainably. You can learn more about Scott on his website ScottSery.com
  • http://www.debtroundup.com/ Grayson @ Debt Roundup

    I have loaned to a family member before and borrowed as well. We set terms and signed a “contract” to deal with the payback. Each was an enjoyable experience and I would probably do it again. The amounts were not a lot as I would have to think more about those situations. It all depends on your family dynamic.

    • http://www.onesmartdollar.com/ Sean @ One Smart Dollar

      It really does depend on the dynamics between the parties involved.

  • http://www.moneylifeandmore.com/ Lance@MoneyLife&More

    I have on very short term basises and was paid back. However, as with any loan to a friend or family I don’t expect to be repaid but will never loan them money again if I am not repaid and they are made aware of that fact.

    • http://www.onesmartdollar.com/ Sean @ One Smart Dollar

      Right there with you. If it’s stated that it’s a loan and it’s not paid back, that would be it for me.

  • Bill Myers

    Loaning from family members can always be a fishy process and the gravity and the guilt of it hanging over your head can be far worse for you see family members more often than you see your local banker. However loaning/borrowing with family members seems to be crucial part of life. It is always good to have those terms set in stone, especially with the larger loans.

  • Nick @ ayoungpro.com

    I would never loan money to a family member, too much of a chance for feelings to get hurt. I would give a family member money, but never loan it.

  • http://Www.Plantingourpennies.Com/ Mrs PoP @ PlantingOurPennies

    We borrowed $50K from Mr. PoP’s parents in order to buy an investment property, and it’s been a great experience for everyone so far. We’re planning on paying it back early, but Mr. PoP’s parents are so happy with the interest payments that we’re giving them (5%!) that they wouldn’t mind if we extended it out even further. We actually wrote about it a little while back – http://www.plantingourpennies.com/2013/02/08/more-family-and-money-they-dont-want-it-back/

    • http://www.onesmartdollar.com/ Sean @ One Smart Dollar

      $50k is a huge number and I am really glad that it is working out well for all.

  • http://twitter.com/CanadianBudgetB CanadianBudgetBinder

    I did take a loan from my parents for $5000 pounds when I was upgrading my home to turn around and sell it.The renovations helped bring me in a very nice profit and I paid my parents back with interest even though they didn’t want that That was the only time in my life I have ever borrowed money from a family member. I’ve never had to lend family members money but if they needed it I’m sure I’d be there to them out.

  • http://www.monsterpiggybank.com/ Glen @ Monster Piggy Bank

    I have never had anything but bad experiences with loaning family money with the only exception being my youngest brother who happens to be an accountant.

    I just refuse to do it now as I am afraid of being burned and I don’t want to risk the possible degradation in relationships.

    • http://www.onesmartdollar.com/ Sean @ One Smart Dollar

      At least you learned. Some people might just keep doing it and all they will be doing is causing more tension with family.

  • shepherda

    Good post and an interesting topic. Having participated in “family loans” before – I do see a purpose in them – provided (like you say) they are handled with care and respect. I’d much rather pay a family member interest (if they charge it) than a bank!

    • http://www.onesmartdollar.com/ Sean @ One Smart Dollar

      I would much rather keep the interest in the family.

  • http://twitter.com/TheHeavyPurse Shannon Ryan

    I think the key point when loaning money to a friend or family member is, like you said, be prepared to lose the money and never be paid back. If you are unwilling to accept that possibility, then don’t loan them money but give what you can as a gift, if appropriate.

    • http://www.onesmartdollar.com/ Sean @ One Smart Dollar

      Exactly. If you are not prepared then there will just be tension and you never want that with family.

  • http://luke1428.com/ Brian @ Luke1428

    I’ve loaned to family members before but would not do it again just because of the potential relationship damage. If they were in need, and I had the ability to, I would just give them the money.

    • http://www.onesmartdollar.com/ Sean @ One Smart Dollar

      I agree, I think you need to go into it with the feeling that you are giving them the money.

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  • http://www.onesmartdollar.com/ Sean @ One Smart Dollar

    I think I am in the same boat as you. It would be too tough for me to “loan” money and not expect it back.

  • http://www.onesmartdollar.com/ Sean @ One Smart Dollar

    If it is a loan then you absolutely have to have set terms.

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