A strong family is comprised of trust, love and compassion, among other things. When money issues come into play they can put a strain on everyone involved. The decision to give a loan to a family member is a difficult one. This is a decision that is ultimately up to the person with the money. It is hard to pinpoint a specific answer to whether or not an individual should loan out money because each situation is different.
Here are some guidelines to consider before making the tough decision:
What is The Reason For The Loan?
You may be inclined to respect the privacy of the family member asking for the loan, but it is your money and you have every right to know what it’s going toward. Do your best to figure out the exact reason for the loan. Many times family members turn to each other for loans because there is a lower interest rate or no interest rate compared to bank loans. Some of the most common reasons to ask family for loans:
- Down payment on a home
- Help getting over a divorce, illness or other unexpected expense
- Establishing credit for a younger family member or immigrant
The above examples are common reasons for asking a relative for extra financial help. In some of these cases, asking for a family loan is a smart decision. On the opposite end, if you know the family member has had financial problems in the past, there is a chance you will not see your money again. If this is not a risk you are willing to take do not give out a loan.
Write up a Document
If your family member feels comfortable coming to you for help you should be close enough to draw up an official document. Although it may seem unnatural to go through such a formal process with a relative, it could be of help in the long run. If a problem arises the agreement could help alleviate any tense conversations. Things to include in your agreement:
- Size of the loan
- Interest rate
- When payments must be made
- How will the payments be made
The more detailed the document is the less room there is for something to go wrong later on. Remember: Even the closest families can be torn apart by financial troubles.
Establish an Interest Rate
As mentioned in the above sections you may want to have an interest rate on the loan given out. Granted, this may frustrate the person borrowing, due to IRS regulations you may still have to charge interest. If you do not charge interest on the loan you can end up getting taxed by the IRS. Loans below $10,000 will typically fall under the radar but if you go over that amount you will probably want to talk to a CPA to figure out the best action to take.
The most important thing to do when a family member asks for money is to think about what it can do to the relationship. Think about every outcome that can possibly happen and whether or not the relationship is strong enough to overcome any financial problems that may arise.