Nearly everyone has probably borrowed money from a family member at one time or another, but getting $20 to fill the gas tank is a far cry from asking for a loan to start a business or put a down payment on a house. Lending larger sums of money to a family member can be incredibly helpful to the borrower, but a defaulted loan has the potential to ruin relationships, so it’s wise to tread carefully when it comes to money and family.
These are a few things to keep in mind when you’re considering lending money to a loved one.
- Don’t Skip the Paperwork: Even though you’re not a bank, creating a loan agreement is still a very good idea. There are loan contract templates online to get you started, but some basics to include are the amount lent, interest rate, and terms of repayment.
- Not Building Credit: Young adults often need to borrow from their parents for big expenses (like buying a first home). It’s important to keep in mind, though, that while the interest rate on a family loan is likely to be low (or zero), it’s a loan that won’t help you establish or rebuild good credit.
- Tax Implications: The IRS has established minimum interest rates, even on family loans. If you don’t charge any interest, the IRS considers that a gift—and monetary gifts are taxed differently. To avoid complications later, make sure you’re using the current federal loan rate and documenting the loan properly.