How can I make a personal loan to a family member?
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UPDATED: Jul 6, 2012
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Family members often help each other out by lending money to one another. Whether these family-originated personal loans are for the purchase of property, starting a business, or making important payments, it is vital that a document or contract be written and signed by both parties.
Contracts exist in order to protect both parties involved in a personal loan agreement. The clauses contained in contracts spell out what will happen should a borrower and lender have a disagreement.
The Pre-Contract Phase
Before loaning out money, both parties should meet to discuss the terms of the loan. Discussing the amount needed and the amount being lent is very important since the lender and borrower may have differences of opinion.
Included in this discussion should be the interest rate, a payment plan, the loan’s duration, and whether any securing collateral is necessary.
While these fiscal topics may be difficult to discuss with family members, they are important steps to minimize any arguments or conflict that may arise in the future once money is lent.
Once the terms have been orally agreed upon, a contract can be drafted.
The Binding Agreement
The contract should be written to include the amount of the personal loan, the interest rate, the agreed-upon monthly payment, the details of any collateral, and an explanation of what will happen should the borrower default.
A completed personal loans contract should be notarized before money is transferred. Money should be transferred via check or wireless transfer, but not via physical cash. This is not only expedient for large sums of money but it also creates a potentially useful paper trail. Giving physical cash to family members is not wise since it has virtually no paper trail that could be useful in solving any grievances.
Personal loans between family members can be advantageous since family often offers lower interest rates than traditional lenders would.
But while family members may be tempted or even pressured to loan out money free-of-interest, the IRS might consider such a transaction as a taxable gift. Taxable gifts result in the lender losing legal rights to gaining back their money. On a similar note, it is illegal to charge an excessive interest rate since this can violate usury laws.
Keep in mind, though, that while we may love our families, it’s crucial to be careful in choosing whom to lend money to. It may not always be wise to loan money to borrowers in a family who are not dependable, as disputes over money are simply not worth breaking relationships over.