Financial advisers don’t always agree, but when it comes to lending money to family, there’s consensus: Tread carefully.
If an adult child needs help buying a first home or has a promising business idea, a family loan can be a fast and convenient option. But there’s a risk of drama down the road.
PROS AND CONS OF FAMILY LOANS
There are advantages of a family loan for a borrower: no credit check, low or no interest and flexible payback terms.
It can also be a way to help young adults learn about financial responsibility, says Walter Pressey, a retired financial industry executive in Boston.
But loans can be uncomfortable for both the giver and receiver. If you’re the family ATM , you may have trouble saying “no” and thus jeopardize your own finances. If you’re the one asking family for money, you may feel a sense of obligation over payments that strains the relationship.
Before loaning money, financial planners recommend considering the impact on your own goals, such as retirement. And while your loved one may have every intention of paying you back, be sure you can afford to part with the money if things go south, says Eric Gabor, a certified financial planner with Eagle Grove Advisors in New Jersey.
Family loans may also come with tax considerations. Charge zero interest, and you may face a gift tax; a borrower who receives a gift may have to report it as taxable income. Tack on an interest charge and you must follow IRS-specified guidelines for the rate you charge and report it as income.
One way to avoid future problems is to use a family loan agreement, says Derek Tharp, a certified financial planner at Conscious Capital in Cedar Rapids, Iowa.