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It’s natural to want to help your family. When a family member asks you for money, though, it can be awkward. Lending money to someone you know is risky, and surveys show it can lead to hurt feelings or strain a relationship.¹
On the flip side, a family loan could help a relative who’s going through a tough time if you can reach a reasonable agreement. It’s a personal choice since you’ll have to factor in your financial situation, tax rules on gifting or loaning money, and whether the person will likely pay you back on time.
Here’s what you’ll need to know to decide if loaning money to family is the right decision for everyone involved.
Family loans: loaning money to loved ones
Personal loans, while helpful for goals like debt consolidation, can come with many conditions and, sometimes, a high interest rate. A family loan is more informal, but it doesn’t have to be a handshake agreement either.
Since a family loan comes with an expectation of repayment, you can set agreeable terms between you and your family member with a written contract.
At least one in five adults in the U.S. receive financial support from friends or family, according to the Consumer Financial Protection Bureau.² A Finder survey found that, in 2018, Americans borrowed $184 billion from family members.³ The average family loan amount totaled $3,300 in that survey.
With a family loan, you will determine how much you want to loan, whether you’ll charge interest, and the repayment schedule. Creating a written loan family loan agreement protects both parties by confirming the loan terms to prevent any future disagreements.
If the loan amount exceeds $10,000, the IRS requires a written agreement for the loan. The agreement needs to include detailed repayment terms and a minimum interest rate. Family loans over $10,000 also require you to report any income earned from interest payments on your taxes.4
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Pros of loaning money to family
- Help a loved one going through financial hardship: When someone asks you to borrow money, it could be as a last resort or to get aid for a serious emergency expense. If their intentions are sincere and they agree to repay the money on time, managing a family loan could be a smooth process.
A loan to a family member with a history of bankruptcy can help them secure money for an investment when their financial history bars them from getting traditional loans. That said, check your gut and investigate your family member’s intentions when loaning money to loved ones with such a history.
- No credit restrictions: Banks, credit unions, and online lenders require a credit check with loan applications. If your relative has bad credit, a family loan helps them avoid a higher loan interest rate and another hard credit check that could ding their score further.
- Lower interest rate: Since you know the person you’re lending money to, you probably don’t want to charge them a high interest rate. Otherwise, you can choose a reasonable interest rate or not have one at all for the loan.
- Opportunity to negotiate: Family loans allow more room to negotiate the amount, repayment term, interest rate, and a security deposit if you ask for one.
Cons of loaning money to family
- Mixing emotions and finance: Lending money to a family member may not work for everyone since the emotional aspect could outweigh your financial judgment.
For example, you heard your uncle had a car accident and needs money for vehicle repairs. You easily sympathize with the situation, especially since you know him personally. However, this could impact your ability to set reasonable loan terms, and you may feel guilty about charging a small interest rate.
- Higher risk: Family loans are higher risk since almost half never get repaid. A CreditCards.com survey revealed that 42% of family lenders were not repaid, and 59% of them experienced issues with receiving the money as agreed.5
- No opportunity to build credit: Money you lend to family won’t help them build credit history since the payments aren’t reported to the major credit bureaus. Credit is a valuable tool that could help your loved ones qualify for alternative lending options in the future.
- Tax implications: Your generosity through a family loan could lead to tax implications depending on how much you offer. Check the latest terms and requirements about lending family members amounts that exceed $10,000.
What you need for a family loan
All loans include a formal agreement, and a family loan should be no different. An agreement puts the loan terms in writing and details what would happen if the borrower cannot repay the money.
A promise to pay the loan back, or a “handshake agreement,” isn’t enough to guarantee the loan. Drafting a loan agreement keeps both parties accountable for what they agreed to do.
You don’t need special paperwork to create the loan agreement, but you could consider free templates online or talk to a legal professional. Your document should include information like:
- The loan amount
- The purpose of the loan
- How the lender will issue funds and when
- The repayment term length
- How funds should be repaid (monthly installments, lump sum by a specific date, etc.)
- Interest rate on the loan (if applicable)
- Any additional fees
- Consequences of nonpayment (late fees, taking legal action, or seizing any collateral)
Both the lender and the borrower should sign the agreement only if they agree to the terms.
What to do instead of loaning money
A family loan is not always the answer. Maybe you can’t afford to lend a loved one money or believe they wouldn’t be able to repay you on time.
In this case, you may not want to go through the effort of negotiating loan terms and forming an agreement. There are other ways to help loved ones if loaning money is not ideal.
Help family apply for financial assistance programs
Private and state or federal-funded assistance programs can help people pay for food, childcare, and utilities. Rent and mortgage assistance programs also exist for people who demonstrate financial need.
Help your family member contact their local Department of Human Resources office to learn whether they’d be eligible for assistance and how to apply.
Offer paying work
Here’s a hypothetical: your cousin has fallen on hard times and lost his job of 20+ years. He has many skills, though, and could help you with work around your house. Instead of setting up a family loan, you could hire him to complete home renovation projects.
Drive them to interviews and send job leads
Another way to help a struggling family member is to help them with their job search. If someone doesn’t have transportation, volunteer to take them to and from interviews. You can also send them job leads you find online.
Recommend a financial or debt counselor
The National Foundation For Credit Counseling connects people with Certified Credit Counselors that can help them create a debt management plan and a realistic budget.
If someone you know is struggling with debt or unable to manage their income, consider referring them to a financial professional who can help them improve their credit and develop a plan for their finances.
Most credit counseling services are free or affordable, but you can pay for a few sessions for your family member as a gift.
Gift the money instead of loaning it
Giving money to a relative as a gift to help them through hard times is always an option if you feel comfortable. The IRS has a federal gift tax if you transfer money or property worth more than an exempted amount. Each year it is subject to change, but for the 2022 tax year, the maximum gift tax exemption was $16,000. You could gift someone up to $16,000 in one year without worrying about the tax.6
If you give more than this amount, you’ll need to fill out a 709 form when you file your taxes. The federal income tax rates for monetary gifts range from 18% to 40%, depending on the gift amount.7
How to tell someone you can't lend them money
If you find yourself in a situation where you want to help but can’t, tell your family respectfully to keep the relationship intact. Here are some tips to help navigate that conversation without jeopardizing future family events and interactions.
- Empathize with them: Let your family member know that you understand their situation and are sorry they are going through it. Then, politely decline to give the loan because it’s not possible for you right now.
- Be transparent and open: Your reasons for not lending money don’t need to be shared, especially if it’s simply against your beliefs to get involved in another household’s financial matters. However, if you wish to add some context, be transparent and open about your reason, like you’re trying to pay off your own debt or are saving for a down payment on a house.
- Decline and propose another solution: You can still be helpful without loaning money to a family member. Just say you’re sorry that you can’t lend the money and offer a few alternatives or other solutions they can try to get the money they need elsewhere.
Is a family loan taxable income?
As a borrower, there are no tax implications to a family loan. As a lender, you must report any money you earn from interest to the IRS as taxable income.
Are family loans legal?
Yes, you can lend money to a family member at any time, but you must follow tax laws. While it’s not required, it’s always a good idea to protect yourself legally with a written contract.
Can you give a family member an interest-free loan?
Yes, but you or the borrower may have income tax charges if you don’t charge interest that meets the applicable federal rate (AFR) standards set by the IRS. The AFR gives you a guideline to set a reasonable interest rate for the loan.
You could also give a monetary gift instead of a loan. Depending on the amount, you might have to pay taxes on the gift.
How do I ask for a family loan?
Consider your situation and financial need to decide if a family loan is the best solution. Ask yourself if and how it could disrupt a relationship with your relative and what you can do to prevent this.
Explain your situation in detail. Then, upon asking for the loan, share some reasonable ideas for the terms, like the repayment length and interest rate, to make the negotiation process easier.
Should you lend money to your family?
Loaning money to family is tricky, and family loans are just one of several options you have. Follow our tips to ensure that lending money doesn’t cause issues in your relationship.
If you’re going to issue a family loan for a large amount, like $1,000 or more, get your loan terms in writing. Also, don’t be afraid to offer help in non-monetary ways, which can still make a considerable difference.
Now that you have a bit of experience mixing family and finances, learn about some different methods of co-managing finances with your partner. For more Love & Money, find out when you should bring up a prenup.