Guidelines for borrowing from family
Borrowing money from family or friends can be beneficial for both of you—but it comes with unique risks. Here are seven steps to take when you ask a relative or friend to write a check.
Get your financial house in order
Before you ask anyone for money, demonstrate you are responsible enough to handle a loan—that you make good decisions about your own money. That means tracking your monthly spending, paying bills on time, and aggressively paying down any outstanding debt.
Understand that the risks go beyond your wallet
When you borrow from a family member, there’s more than money at stake. If you can’t honor your end of an agreement, it can hurt feelings and breed resentment between you and the people you care about. Consider that risk carefully, and take your time working with your family member to structure realistic terms that work for both of you.
Tell the truth
Whether you need money to go back to school, start your small business or cover an emergency expense, be honest. Whether or not your family members ask you to provide collateral to back the loan, they put faith in your word that you’ll pay them back. Because of the trust in that relationship, it’s important to be clear about your intentions from the very start.
Make it official
A loan is a business transaction, and it helps both parties to keep it professional in case of any disagreements. If you’re not sure if your agreement is legally sound, or if you want some assistance, a legal advisor can help you draft an agreement that covers the key elements.
Put it on a schedule
Your formal agreement should include the type and frequency of payments you plan to make. You can work together on a schedule that reflects your needs and the lender’s: For example, if it’s a large loan and you have a steady income, it might make sense for you to make fixed monthly payments. For small or short-term loans, you might decide to repay the full amount on a certain date.
Mind the IRS
Federal tax laws impose a gift tax on total gifts greater than $14,000 within a single calendar year. Except in cases of certain loans of less than $10,000, charging interest is a good idea to prevent the IRS from treating the loan as a gift. The IRS sets minimum interest rates that friends and family are required to charge, known as Applicable Federal Rates, and updates those rates monthly. These rates tend to be much lower than typical bank loan rates, which could reach into double digits depending on your credit score.
Don’t let small problems become big ones
Think the interest rate is too high? Worried you won’t be able to make your monthly payment? Talk to your family member immediately and let him or her know that you’re having an issue. Do not wait for problems to boil over and get worse—be forthright in your approach, and ask the lender to work with you to figure out solutions together.