Borrowing money from family members — or lending it to them — can be a risky business. And although all debt is risky, family loans carry different kinds of dangers.
Although family lenders don’t have to worry about pulling (or affecting) anyone’s credit score, private loans may put a strain on otherwise strong relationships. Depending on the size of the loan, there may also be tax implications to consider.
That said, there are ways to thoughtfully issue and receive family loans. Here are our best tips for stacking the odds in your favor.
What Are Family Loans?
Family loans are those that are given and received within a family group, instead of a typical lending situation like a bank or credit union, or even a payday lender.
Someone who may not be able to qualify for a traditional loan might be inclined to ask a family member for a loan.
Sometimes a family loan might work in the interest of both parties. For instance, the borrower might receive a more favorable interest rate than they might have from a bank, and the lender might receive a higher interest rate than they would find in a savings account.
Reasons someone might ask a family member for a loan are similar to reasons they might consider a personal loan: They might need cash for emergency medical expenses, unexpected home repairs, or expenses for adoption or fertility treatments.
How Do Family Loans Work?
At their most basic, family loans work similarly to traditional loans: One person asks for a loan, and another person approves the request. While that is an oversimplification, the concept is the same. There is generally less paperwork involved in a family loan, with no application or credit check necessary, although a formal contract detailing each party’s rights and responsibilities is recommended.
Terms for the Lender to Include in a Family Loan
• Amount loaned.
• Interest rate, if interest is charged.
• Payment amount (often, monthly).
• Penalties for non-payment.
Terms for the Borrower to Include in a Family Loan
• Amortization schedule, with principal and interest amounts clearly stated.
• Ability to pay the loan off early without penalty.
• Periods of payment suspension in cases of hardship.
Risks and Benefits of Family Loans
No matter which end of the dynamic you might find yourself on, there are both risks and benefits to family loans. But while both the borrower and lender risk putting a strain on the family relationship involved, the lender is likely to carry the greater financial risk — after all, it can be pretty hard to recoup your losses when you have no official financial authority.
Risks of Family Loans
One of the biggest risks of loans between family members is the potential for conflict within the relationship. People tend to have strong emotions tied to money. Some risks lie with the borrower or lender alone, though.
Risks for the Borrower:
• There is risk to the relationship if the loan repayment plan falls through.
• Although avoiding a credit check — and possible negative credit consequences — is a plus, family loans also fail to help borrowers build their credit history since they’re not reported to credit bureaus.
Risks for the Lender:
• There is risk to the relationship if the loan repayment plan falls through — which puts the lender into a particularly tricky situation if they really need the cashback for their own financial situation.
• It’s easy for family lenders to lose their money outright if the borrower constantly defers to an IOU.
• Since family lenders don’t have any financial authority or backing, it can be difficult to recoup losses or enforce any substantial consequences for borrowers who go into default.
• If the loan is interest-free and for an amount in excess of the IRS gift tax exclusion , it may trigger the need to file a gift tax return (and potentially pay taxes on the gift).
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Benefits of Family Loans
Despite their risks, family loans do have some attractive qualities.
Benefits for the Borrower:
• Family loans present a potentially low-cost alternative to traditional credit options. Family lenders usually don’t assess fees and may not charge interest.
• Family loans can carry much easier approval standards than their official counterparts. At a financial institution, borrowers are subject to a credit check, employment history, income verification, and more. A family member is not likely to run those checks.
• Family loans often carry more flexible repayment standards than traditional loans do, and family lenders may be more lenient if the borrower faces extenuating circumstances that make it difficult to make payments.
• Failure to pay private family loans in a timely manner — or at all — won’t impact the borrower’s credit score the way such behavior would with a traditional loan.
Benefits for the Lender:
• It can feel rewarding to help out a family member in need, particularly if they’re putting the money toward a major life goal like homeownership.
• If the lender chooses to charge interest on the loan, they can earn interest as the loan is repaid.
Tax Implications of Family Loans
It can be surprising to learn that loaning money to a family member could be a big enough deal to land on the IRS’s radar.
Fortunately, most family loans fall outside of the purview of the IRS. It’s only when they’re above IRS-defined amounts and interest-free that lenders have to report them on their tax return.
If a family lender offers an interest-free loan to a family borrower, the IRS still sees the transaction as a loan — and assumes that the interest that should have been charged counts as a gift to the recipient. (The government publishes minimum interest rates on a monthly basis.)
That’s no big deal if the loan is for, say, $300. But if the unpaid interest — or unpaid loan balance — tops the annual gift-giving exclusion, which is $15,000 for 2021, the lender might be responsible for filing a gift tax return and potentially paying taxes on the gift.
The IRS might also count the should-be interest toward the lender’s gross income, even if no interest is charged or received. Again, this isn’t a big deal with rates under 1% on loans of just a few hundred dollars, but with a big enough loan, it could impact the lender’s finances.
Making a Family Loan Legitimate for Tax Purposes
The main thing that makes a family loan legitimate to the IRS is a family loan agreement that specifies repayment terms. If an agreement is not in place, the agency may consider it a gift instead of a loan.
The federal government sets minimum interest rates — Applicable Federal Rates — that lenders can charge on a private loan, which a family loan is. If less than the minimum interest rate is charged, the IRS may assess taxes on any unpaid interest that is deemed payable.
Keeping records of payments made will also show the IRS that the lender was keeping track of the debt and that there is an expectation of repayment.
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Tips to Successfully Borrowing From or Lend Money to Family
If you’re considering lending money to or borrowing money from a family member, adding some structure to your loan can help minimize the risks while still allowing everyone involved to reap the benefits.
Planning Your Family Loan Out
All too often, a family loan takes place in a single, impromptu transaction: The borrower asks for some money, and the lender gives it.
Instead, making a concrete plan together specifying all the loan’s terms, such as repayment installments and timing, is recommended. Lenders might want to consider charging interest, especially on large loans, due to the tax implications outlined above. Even a low family loan interest rate can motivate a borrower to get serious about repayment.
Making a Family Loan Official
Clear communication and boundary-setting skills make pulling off a family loan a positive experience for all involved — and oftentimes, the best way to achieve those goals is to write things down.
Plus, drafting a formal money-lending contract makes your loan official in the eyes of the IRS, which can help keep loans from being classified as gifts for tax purposes.
Terms to include in your family loan agreement include:
• The amount loaned.
• The loan’s repayment terms, such as frequency and amount, as well as a due date for when the loan must be repaid in full.
• The loan’s interest rate and fees, if any (for instance, the lender may decide to charge late fees if the loan repayment terms are not honored).
• Clauses concerning what happens if the loan is repaid early (is there a prepayment penalty?) and what happens if the borrower goes into default for any reason.
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Family Loans vs Gifts
If a family lender has the financial ability and willingness to make a monetary gift instead of a loan, they can do so without tax implications for amounts up to $15,000 (for gifts made in 2022, this amount will increase to $16,000).
There are various reasons why someone might choose to give a gift instead of making a loan, or vice versa.
|Interest rates can be advantageous to both parties.||There is no expectation of repayment for a gift.|
|Written agreement legitimizes the loan for tax purposes.||No paperwork necessary.|
|Family loans have potential to cause conflict.||Giving a gift is generally construed as a positive thing.|
|The IRS determines minimum acceptable interest rates and loan amounts subject to those rates.||Gifts under a certain value are excluded from the IRS gift tax in most cases.|
Alternatives to Family Loans
If all of these caveats and warnings are making family loans sound like a less-than-prudent idea, there are alternatives to consider before asking family members for a loan. (And yes, if a family member asks you to borrow money, you’re allowed to say no and steer them in a different direction.)
Obviously, the most ideal financial strategy for making a big purchase is to save your money so you don’t have to go into debt at all. Although this isn’t always possible or realistic, it might be worth taking a second look at your budget, working on a promotion, or starting up a side hustle to generate cash.
Unsecured personal loans are available from certain banks and financial institutions and make it possible to fund a wide variety of expenses upfront. Of course, these may come with higher interest rates and more stringent qualification requirements than family loans do.
You might also consider asking a family member to cosign on a loan with you instead of loaning you the money. They would be responsible for making the loan payments if you, the primary borrower, don’t, but they wouldn’t be immediately taking money out of their own bank account to help you.
If you need to borrow money for business purposes, a small-business loan may be an option to think about. The Small Business Administration is an excellent resource for business loans. The agency works with lenders to help small business owners find funding for a wide range of amounts and terms, with competitive interest rates.
While borrowing money from or lending money to a family member can be tempting, it can have long-lasting impacts on interpersonal relationships as well as the lender’s finances. While drafting a structured family loan agreement can help, personal loans can be an alternative worth considering.
SoFi offers a range of low-fixed-interest-rate unsecured personal loans that can be used to fund medical expenses, home renovations, moving costs, and more.
Curious to know how a SoFi personal loan could help you? Check your rate today — it won’t affect your credit score.1
What is a loan from a family member called?
A loan from a family member is often referred to as a family loan, an intra-family loan, or a friends and family loan.
Can family loans help your credit?
Since a family member is not likely to formally check your credit report or provide payment information to the credit bureaus, a family loan probably won’t help your credit.
Are family loans considered debt?
Yes, a loan from a family member is considered debt, but will likely not be reflected on your credit report. For tax purposes, a family loan is considered debt if it meets certain guidelines.
1Checking Your Rates: To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, we will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.
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