Family Loan Agreements: Lending Money to Family & Friends (2022)

Money is a funny thing when it passes between family and friends, especially if you are the one borrowing from or lending to a member of your family or a close friend.

The Federal Reserve Survey of Consumer Finances says loans from family and friends amount to $89 billion each year in the United States. A company called Finder did some math after a 2018 survey and said the number was more like $184 billion. Either way, there’s a lot of cash flowing between family and friends.

The most popular reasons for asking family members or friends for a loan are tostart a businessor purchase a home. A national survey by Fundable said that 38% of startup businesses relied on money from family or friends. The National Association of Realtor said that 52% of first-time home buyers used money from family, mostly parents, or friends to buy a house.

Another good reason for seeking a loan from loved ones is when a family member becomes unexpectedly unemployed or is hit with a sudden illness. Other popular reasons include buying a car, a computer or other technical equipment or something more personal like an engagement ring or to pay for a family vacation.

How to Borrow from Friends or Family

The main advantage of receiving a loan from a friend or family member is that your “lender” is more likely to be flexible about the amount borrowed and payment arrangements. That means you could borrow 100% of the amount you need at a very low-interest rate – possibly 0% — and get an affordable monthly repayment schedule.

Treat a personal loan issued by a loved one with the same respect and professionalism as you would a loan from a bank. If you plan to borrow money from a bank, credit union or other lending institution, you already know you must be prepared to sign a legal contract outlining your obligations to the lender: On time payments until the loan is paid in full. This contract is called a promissory note.

(Video) How to Lend Money to Family and Friends And Get Paid Back

Should it be any different if you borrow money from friends or family? Not really. Even though they may have known you for years or even a lifetime, they still need assurance that you’ll pay them back as promised. The fact you know them really well doesn’t remove any of the obligations and responsibilities associated with taking on a loan.

It is a wise move to draw up and sign a loan contract regardless of your relationship with the lender. This protects both parties in case of a disagreement. A loan agreement between two individuals is more simplistic but very similar to a standard bank promissory note.

Basic terms for a loan agreement with family or friends should include:

  • The amount borrowed (principal)
  • Interest rate (if applicable)
  • Repayment terms (monthly installments over a set period of time or a lump sum on a certain date)

One of the most important things to address in a loan contract with a friend or family member is what will happen if you can’t pay?

The loan agreement should clearly state the lending party’s recourse in case of nonpayment, including:

  • Adding additional costs to the loan
  • Modifying the loan terms
  • Taking ownership of collateral
  • Pursuing legal action

What Happens When You Default?

Like any loan contract, you’re legally on the hook for the debt. If you fail to abide by the terms of the agreement, your lender — in this case, your loved one — can take legal action against you. With the contract as proof, the lending party can sue in small claims court, get a judgment and then pursue collection activities on the loan — such as wage garnishment or property liens — just like other creditors.

If you cannot negotiate more reasonable loan terms privately, a lawyer might be able to either negotiate on your behalf to include part of the balance due in adebt settlement agreementor add it to adebt consolidation loan. It is important to take action before a judgment is entered in small claims court because the lending party can often pursue your personal assets, bank accounts and wages.

(Video) Why You Should Never Loan Money To Family - Dave Ramsey Rant

Preserving the Personal Relationship

Everyone has ups-and-downs with their finances, but things get really uncomfortable when you take family or friends on a roller-coaster ride when repaying a loan. Relationships built over years or even decades, crumble when conditions of a loan agreement are ignored or broken.

If you fall behind on a loan from a loved one, it is important to keep the lines of communication open. Good communication is the best way to avoid animosity with family and friends who have loaned you money. Like it or not, a person lending money feels like it’s an investment. They want to know how the project or business is doing and whether this loan is going to be paid off.

That is why it’s so important to have everything about the loan down on paper. It’s easy to reach a verbal understanding with family and friends, but difficult to remember the details a year later. Write it all down and make sure both sides understand the details of the agreement.

A borrower should consider giving lenders periodic updates (monthly, quarterly or annually) to discuss the project or business. It helps to know in advance that there may be problems paying the loan and if there are alternative relief options while the problem is resolved.

Finally, both sides should anticipate there will be trouble spots and decide ahead of time how they will respond. Emotions run high when both sides appear to be losing money. There isn’t much to be gained getting into a heated argument with family or friends over debt.

Both sides should be realistic about what is expected. The borrower should make repaying the loan a top priority. The lender should expect some problems. That is usually why they were asked for the loan in the first place.

What to Do If You’re the Lender

The lender has the most to lose, literally and figuratively, in situations where there is a loan agreement with family or friends. The lender not only puts his money at risk, he puts his reputation and relationship in danger, too. He could lose it all – money, family and friendships – if things go wrong and he stands to gain little more than a few dollars of interest if everything goes right.

(Video) 7 Things to Consider When Lending Money To Friends & Family

That is why people must think long and hard before loaning money to family or friends. It can be a costly exercise.

Here are a few things, some very stark, to consider before making the loan:

  • What is your family’s net worth and can you afford to tie up your money for whatever time period is suggested?
  • Would you be willing to foreclose on the borrower or sue if they default on the loan?
  • Would you impose penalties for late payments?
  • Would you get involved in the project or business to help get your money back?
  • Have all other options been exhausted: Banks, credit unions, other family members.
  • If lending institutions won’t give them money, do you really want to take on the risk?

If you have examined all the negative outcomes associated with making a loan and decide to go through with it, here are a few steps that might help toward a positive outcome.

  • Ask for a plan. The borrower should furnish details of what the money will be used for, the schedule for repayment and what will happen if he defaults on the loan.
  • Review the borrower’s finances and help them set up a budget that includes your monthly repayment.
  • Make sure they understand this is a loan, not a gift.
  • Set terms that both sides agree can be enforced … and enforce them!
  • Keep your distance. Just because you give someone a loan, doesn’t mean you can meddle in the project or business.
  • Get it down on paper. It’s easier to settle arguments when everything is written down – and signed!

Tax Implications of a Family Loan

According to the Federal Reserve Board Survey of Consumer Finances, loans from family and friends amount to $89 billion each year in the United States. The most popular reasons for asking family members or friends for a loan are to start a business or purchase a home. A national survey by Fundable said that 38% of startup businesses relied on money from family or friends. The National Association of Realtor said that 6% of first-time home buyers used money from family, mostly parents, to buy a house.

Dealing with the IRS is one of the critical, but often overlooked aspects of loans between family members or friends. Both borrower and lender have responsibilities, though most of them fall on the person lending the money.

The first thing the IRS wants is clear proof that this is a loan and not a gift. That means charging and collecting interest under the IRS rules for applicable federal rate. The minimum rate in 2021 was 0.25% for loans of less than three years; 0.58 % for loans of three-to-nine years; 1.15% for loans more than nine years.

If the parties involved are not paying and collecting at least that much in interest, the IRS could deem the money a “gift” and apply gift taxes, depending on the amount.

(Video) Never loan money to family or friends

The next step is to draw up legal documents for the loan. If the loan is for a home, that includes a deed of trust and recording the loan with the county.

The two sides must sign a promissory note that spells out the interest rate, terms and conditions, length of repayment period and ability to transfer the loan to another party.

There also should be an amortization table that shows the amount of principal and interest paid and the balance due after each month for the lifetime of the loan.

The lender must file IRS form 1098 stating how much interest the borrower paid over the course of each year. The lender also must file IRS form 1099, which states how much interest he received on the loan and report that amount on their tax return. This is an essential step in the loan process as there are severe tax consequences if any of these steps are missed.

Alternatives to Loans from Family Member

A 2009 survey by CNN Money reported that 27% of people who lent money to family or friends didn’t receive any money back and 43% were not paid in full. In other words, most of the time loans between family and friends don’t work and destroy relationships.

However, there are alternative sources of money if you want to avoid the very real possibility that taking or giving a loan to a family member or friend will not result in a good outcome.

Admittedly, it will be difficult to tap some of the sources for mortgage loans, house renovations or car loans, but if you’re looking to start a business, the Small Business Administration is a government agency dedicated to serving small businesses. They offer a variety of loan programs, including a General Business Loan that could get you $50,000 to $250,000. The SBA also has a Microloan program that offers up to $50,000 for startups and some non-profit childcare centers.

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When you go online, there are peer-to-peer lending sites such Lending Club and Prosper or crowdfunding sites like Kickstarter and Crowdfunder may deliver the loan you don’t want to ask Mom and Dad for.

If you’re looking for something that will help with a renovation or be a down payment for a home or new car, you could consider borrowing from your 401(k) retirement fund or doing a home equity loan or home equity line of credit (HELOC).

FAQs

How do I legally lend money to my family? ›

Before you extend a loan to family, however, be aware that it's not as simple as just writing a check. The IRS mandates that any loan between family members be made with a signed written agreement, a fixed repayment schedule, and a minimum interest rate. (The IRS publishes Applicable Federal Rates (AFRs) monthly.)

How much money can be legally given to a family member as a loan? ›

Smaller family loans of less than $10,000 can typically be handled informally and aren't subject to the same complex interest rate rules that larger loans are (more on this below). Large family loans of over $10,000 can be a bit trickier and are subject to IRS tax rules.

What is loan from family or friends called? ›

Monies, usually in the form a loan, that a business owner gets from either family members or friends in order to help finance their startup or growing business.

Can you legally loan money to a friend? ›

Is lending money legal? Yes, it is. It is legal to lend money, and when you do, the debt becomes the borrower's legal obligation to repay. For smaller loans, you can take legal action against your borrower if they do not pay by taking them to small claims court.

Is a family loan agreement legally binding? ›

A Loan Agreement between family and friends is a legal and binding contract. This contract stipulates the terms and conditions of the loan and generally formalises the amount lent, repayments and term of the loan.

Can I give an interest free loan to a relative? ›

Yes, any person can make an interest free loan or loan on a subsidised rate to friends or relatives however, such loan should not be granted or recollected as cash . The transaction must be through a bank account in various ways such as payee cheque, electronic transfer, bank draft and so on.

Do you have to pay taxes if a family member loans you money? ›

In most cases, you won't have to pay taxes for a “loan” the IRS deemed a gift. You only owe gift tax when your lifetime gifts to all individuals exceed the Lifetime Gift Tax Exclusion. For tax year 2021, that limit is $11.7 million (increasing to $12.06 million in 2022). For most people, that means they're safe.

Can my parents give me $100 000? ›

Current tax law permits anyone to give up to $15,000 per year to an individual without causing any federal income tax issues or reporting requirements. Let's say a parent gives a child $100,000. The parent would have no tax to pay on that gift nor would the child have any tax to pay upon receipt.

Can I lend my daughter money to buy a house? ›

If you are providing your child with money towards their home as a gift, the mortgage lender will require you to sign a deed of gift confirming that you have no right to the money once it has been given to your child.

What is a family loan agreement? ›

A family loan agreement is made between a borrower that agrees to accept and repay money to a lender related by blood or marriage. Its main purpose is to be a simple agreement made between family members. If interest is charged, the lender cannot impose more than the State's Usury Rate.

What is a friendly loan agreement? ›

“A friendly loan is a loan between two persons based on trust. They may be an agreement such as an I.O.U. or security pledged to repayment but most important there will be no interest imposed.”

What is the minimum interest rate for a family loan IRS? ›

The Internal Revenue Service has released the Applicable Federal Rates (AFRs) for May 2022. AFRs are published monthly and represent the minimum interest rates that should be charged for family loans to avoid tax complications. The Section 7520 interest rate for May 2022 is 3.0 percent.

What is a disadvantage of a friends and family loan? ›

business failure would mean friends and family losing money. a default on loan repayments would affect personal relationships. there are tax consequences to the lender if interest is charged. even if interest is not charged, the lender will need to consider the consequences of inheritance tax.

How much interest should I charge a friend for a loan? ›

Charging interest on your loan is certainly your right. How much that interest should be is up to you, but you'd probably want to charge no more than a bank. Typically, lenders will charge anywhere from a friendly 6% to an obscene 36%. Before inflation kicked in, it was easier to find loans for under 6%.

Can a family member lend me money to buy a house? ›

Everyone legally has the option to borrow from family or friends if both parties are willing. If you handle loaning money correctly, everyone can end up winning. These loans are often referred to as private home loans, a personal loan or an intra-family loan. They are not as uncommon as you might imagine.

Can I give my daughter an interest free loan? ›

Where the parent hands over money for the deposit as a loan, it is important to have a proper legal agreement in place. The most common way of doing this is for the parent to grant an interest-free, or low-interest, loan, repayable when the property is sold.

Does a loan agreement need to be registered? ›

Under section 17 of Registration Act any document which purpose to transfer any interest in immovable property should be registered. Since a Mortgage Loan creates a charge on the property in favour of the bank, it effectively amounts to a limited or conditional transfer of interest in the property.

Will I have to pay income tax if someone transfers money to my bank account? ›

Only to meet Personal Expenses

This has no income tax implications and is not considered as an income in the receiver's hands. However, any interest earned from a bank account may still be clubbed.

Should I lend money to a friend? ›

If lending money to someone puts a strain on your finances, or if you have to sacrifice a lot to manage your expenses after that, you should avoid doing it then. However, if you have enough savings or a big enough emergency fund, and little or no debt, you could perhaps help out a friend.

Do you lend money to your friend give reasons? ›

Solution. A friend in need is a friend indeed. If the friend fails to repay the money, the friendship can go sour. My timely help will earn me his trust.

What are the tax implications of loaning money to a friend? ›

Loans Bearing a Market Rate of Interest

The person lending the money must report the interest payment as income on his or her yearly tax return. If the person borrowing the money uses the loan proceeds for business purposes, he or she is entitled to a deduction in the amount of the interest paid.

Can I lend my brother money to buy a house? ›

The bank of mum and dad (BOMAD) is the phrase used when children are borrowing money from family to buy a house, however lending money can be from anyone in the family including grandparents and siblings.

How does IRS know you gifted money? ›

Filing Form 709: First, the IRS primarily finds out about gifts if you report them using Form 709. As a requirement, gifts exceeding $15,000 must be reported on this form.

How do you gift a large sum of money to family? ›

To do this, you've got to use IRS Form 709 when filing your annual tax return. You need to complete and submit Form 709 for any year that you make a taxable gift. Sending in the form doesn't necessarily mean you'll have to pay anything on the gift — it's just the form you'll need to use to declare the gift.

Can my parents give me 50k? ›

You can gift up to $14,000 to any single individual in a year without have to report the gift on a gift tax return. If your gift is greater than $14,000 then you are required to file a Form 709 Gift Tax Return with the IRS.

How do I set up a private loan agreement? ›

To draft a Loan Agreement, you should include the following:
  1. The addresses and contact information of all parties involved.
  2. The conditions of use of the loan (what the money can be used for)
  3. Any repayment options.
  4. The payment schedule.
  5. The interest rates.
  6. The length of the term.
  7. Any collateral.
  8. The cancellation policy.

How much money can you gift someone to buy a house? ›

Tax Implications for the Giver of a Down Payment Gift

As of 2022, you could give up to $16,000 to any one person without incurring the gift tax. If you're married and file a joint return, you and your spouse can jointly gift up to $32,000 to a child or other family member.

How much money can my parents give me to buy a house? ›

Gift Tax Rules

That means that you and your spouse can each gift up to $15,000 to anyone, including adult children, with no gift tax implications. If your child purchases a home with a spouse or fiancé, you and your spouse could each gift up to $15,000 to the buyers for a total of $60,000.

Do I need to pay tax on borrowed money? ›

Personal loans generally aren't taxable because the money you receive isn't income. Unlike wages or investment earnings, which you earn and keep, you need to repay the money you borrow. Because they're not a source of income, you don't need to report the personal loans you take out on your income tax return.

Can you loan money without being taxed? ›

Borrowers can use personal loans for all kinds of purposes, but can the Internal Revenue Service (IRS) treat loans like income and tax them? The answer is no, with one significant exception: Personal loans are not considered income for the borrower unless the loan is forgiven.

How much money can you loan to a family member tax Free UK? ›

Loans that are interest free do not require the recipient or the benefactor to pay tax. If a sum of money is given as a gift, rather than a loan, then it is free from inheritance tax up to the amount of £325,000. This is only true if the donor lives seven years after the payment is made.

Can I write my own loan agreement? ›

However, the do-it-yourself approach is perfectly acceptable and just as legally enforceable. Once you have both agreed on the terms, you may want to have the personal loan contract notarized or ask a third party to act as a witness during the signing.

Can my parents give me $100 000? ›

Current tax law permits anyone to give up to $15,000 per year to an individual without causing any federal income tax issues or reporting requirements. Let's say a parent gives a child $100,000. The parent would have no tax to pay on that gift nor would the child have any tax to pay upon receipt.

Can I lend my daughter money to buy a house? ›

If you are providing your child with money towards their home as a gift, the mortgage lender will require you to sign a deed of gift confirming that you have no right to the money once it has been given to your child.

What is the minimum interest rate for a family loan 2022? ›

The Internal Revenue Service has released the Applicable Federal Rates (AFRs) for May 2022. AFRs are published monthly and represent the minimum interest rates that should be charged for family loans to avoid tax complications. The Section 7520 interest rate for May 2022 is 3.0 percent.

What are the tax implications of loaning money to a friend? ›

Loans Bearing a Market Rate of Interest

The person lending the money must report the interest payment as income on his or her yearly tax return. If the person borrowing the money uses the loan proceeds for business purposes, he or she is entitled to a deduction in the amount of the interest paid.

What are the tax implications of loaning money to family? ›

In most cases, you won't have to pay taxes for a “loan” the IRS deemed a gift. You only owe gift tax when your lifetime gifts to all individuals exceed the Lifetime Gift Tax Exclusion. For tax year 2021, that limit is $11.7 million (increasing to $12.06 million in 2022). For most people, that means they're safe.

What is the lowest interest rate I can charge a family member? ›

Preservation | Family Wealth Protection & Planning

AFRs are published monthly and represent the minimum interest rates that should be charged for family loans to avoid tax complications. The Section 7520 interest rate for January 2022 is 1.6 percent.

Do I have to pay tax on a loan from a family member? ›

There are unlikely to be any immediate tax consequences if parents or other family members make you a loan. But if you agree to pay them interest, the lender may have to pay tax on the interest they receive, depending on their individual tax position.

Can a family member lend me money to buy a house? ›

Everyone legally has the option to borrow from family or friends if both parties are willing. If you handle loaning money correctly, everyone can end up winning. These loans are often referred to as private home loans, a personal loan or an intra-family loan. They are not as uncommon as you might imagine.

How much money can be legally given to a family member as a gift UK? ›

Cash gifts can be a huge financial help for your loved ones, both while you're living and after you've passed away. Everyone is permitted by HMRC to gift £3,000 (tax-free) each tax year, this is known as an annual exemption.

How do you structure a loan from a friend? ›

Create a friends and family investment agreement that details loan terms. Include the loan amount, payment schedule, and a business plan. Also, include what will happen if you or the lender does not follow the loan terms. It would be a good idea to have a lawyer or financial professional look over the agreement.

What makes a loan agreement legal? ›

Loan agreements, commonly referred to as 'facility agreements' are a legally binding document between a lender and a borrower. They set out the terms on which the lender is prepared to loan money to the borrower and the mutual obligations of each party.

How do I write an agreement for money lending? ›

BETWEEN
  1. The Borrower hereto, being in need of money, has requested the Lender to give him an interest-free loan of Rs. ...
  2. The said loan is required by the Borrower for a period of ____ years, commencing from __/__/____ and terminating on __/__/_____.
  3. The Borrower hereby agrees and undertakes to return the loan of Rs.

Videos

1. Loaning Money to Family or Friends
(Attorney/Abogada Elsa W. Smith)
2. Lending Money to Friends and Family Members
(Justin McCarthy)
3. Setting up a Loan Agreement Between Friends and Family
(Goalry Mall)
4. What is a Family Loan Agreement? EXPLAINED
(eForms)
5. How to Loan Money To a Friend or Family Member and Protect Yourself
(Friends Talk Financial Planning)
6. Stewart Welch, III - Loaning Money To Family And Friends
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