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Family Loan

Is a Family Loan a Good Idea?

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Borrowers sometimes find that a family loan is the best option. What does it take to set up a family loan properly? You have to consider financial and personal topics to make sure the loan does not become a nightmare.

What is a Family Loan?

A family loan is any loan between family members. It doesn’t matter what the money is for. It’s just a loan that does not use a bank or other traditional lender.

Financial Considerations

To properly design a family loan, the deal must make financial sense. It should be:

  • A good deal for the borrower
  • A good deal for the lender
  • Compliant with local laws and tax laws
If you start with the goal of a win/win situation, your family loan has a better shot at success.

Tax Laws

Forgiving loan balances or payments, and charging too little interest on a family loan can create problems. Make sure you consult with a tax expert to see if your loan follows all the rules. Lenders generally have to charge at least the Applicable Federal Rate (AFR), and follow other requirements.

Emotional Considerations

A family loan is more than a business transaction. Since you know the other party, you should be aware that personal issues make the deal more complicated. Relationships can end on a sour note, holidays can be awkward, and others (who were not part of the deal) can end up in a tough situation if a family loan goes bad.

To reduce the likelihood of problems, be open about everything. There’s no such thing as being too precise or clear about your objectives. Double check with your family members to ensure they see things the same way you do.

Some people say that these loans are always a bad idea. They suggest that you give the money to the family member, or find another way to help them indirectly. Consider all the possibilities before making a family loan.

Another suggestion is that lenders should be prepared to lose money on the deal. If you’re not willing to risk kissing that money goodbye, a family loan is a bad idea unless you have collateral.

Documentation

The best way to do a family loan is with a formal document. Spell out the terms of the loan just like a bank would. If any collateral is used, be sure the document is sufficient to secure the lender’s interest (work with an attorney to make sure documents will work in your state).

Good documentation keeps everybody on the same page. You can find sample documents online, purchase loan agreements specific to your needs, or pay a service provider to formalize your family loan for you.

Family Loan Services

If you want help with a family loan, there are several services that provide documentation, legal matters, and payments. These P2P lending sites may help with your family loan:

How to Blow It

Setting up a family loan is a big deal. Make sure you watch out for some common pitfalls before you move forward. For more ideas, see 7 Sins of Family Loans

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