Family Loan: Things to Know
At a Glance
Sometimes the best bank to deal with is the one closest to home: your family. But loved ones and money are often like oil and water and can’t (or shouldn’t) mix. If you’re considering borrowing or lending money within the family, there are a few things you should know first.
In this article, you’ll learn:
What is a family loan?
A family loan is a loan between family members and can be a real lifesaver when you need some extra cash to tide you over or tackle an unexpected bill. But, fair warning, there might be some tax stuff to consider, and it could get a little awkward if payments start showing up late (or not at all).
With a family loan, you and the other party will set up an agreement that details the amount of money being borrowed, the interest rate (if any), and the payment terms. It’s also a good idea to establish, in writing, what happens if the loan cannot be paid back. Think carefully before getting into a family loan agreement, as it could cause lasting damage to relationships if not handled properly.
Pros and cons of family loan
Pros
1. Rough credit
The majority of family loans won’t involve a background or credit check, saving the aggravation of navigating the world of credit reporting bureaus. Plus, your credit score won’t be a factor if you’re the borrower, making it easier to get “approved.”
2. Low interest rate
Most family loans will have a low interest rate that’s far under the current market rates, saving the borrower money and making it easier to pay the loan off faster.
3. Mutual benefits
A family in crisis is never good, and helping a family member in need will always have a positive ripple effect for everyone involved. Plus, the person lending the money may be able to earn a little extra with a small interest fee added.
4. Easy approval
You most likely won’t need to submit a stack of paperwork to your uncle just to borrow money, making it easier to get the money you need faster.
5. Cheap loans
By borrowing from family, you can avoid all the extra fees that are typically added to bank loans, such as origination fees, APRs, etc.
Cons
1. Paperwork
Since family loans typically aren’t a standard event in all families, there’s not much available in terms of boilerplate legal documents, meaning drawing up papers will fall on you and the other party. It may get uncomfortable creating contingencies in writing, but that discomfort is all the more reason to ensure everything is written down and understood by both parties.
2. Tax consequences
Gift taxes may come into play based on the amount borrowed and the interest rate offered. It’s a good idea to consult a CPA beforehand so that you understand the tax implications of borrowing money inside the family.
3. Family dynamic
Tensions can run high when money’s involved, especially if payment deadlines are missed, so make sure this is something you consider carefully before getting into a loan agreement with a loved one. Can your relationship, and the other family relationships, withstand losing thousands of dollars?
4. No credit building
One downside of not having your credit score involved in a family loan is that you can’t use the positive payment history to build your credit, making it difficult to get a better score that opens up your chances for competitive loan offers in the future from banks.
When to consider a family loan?
1. Loan terms
Are the loan terms you’re seeing in the marketplace favorable to your financial situation? If so, it might be best to avoid the awkwardness of dealing with your family. If the market is unfavorable, however, it might be best to sit down with your family to discuss if they’d be willing to help you out.
2. Legal remedies
Can you face your family member in court if things go sour? That’s an unfortunate reality many families have had to face when a family loan borrower couldn’t make their payments. There’s also the possibility that legal ramifications could cause you, either as the lender or borrower, to lose thousands of dollars in legal fees in addition to the loan that you should consider.
3. Restricted policies
Are there strings attached to this loan that make it unreasonable for either the borrower or lender? What about outside the family? Many banks won’t accept unsecured loans, like family loans, as down payment options for a mortgage. Are you sure you’ll be able to use the money the way you need to?
Alternatives to family loan
1. Personal loans
Personal loans from banks take the relationship woes out of borrowing completely and are a great way to get the money you need without involving family dynamics. Here are a few of the most popular personal loans we’re seeing now:
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