In this article, we will tell you how to get a family loan. Borrowing money from family is a good and low-cost option if you need cash to repay high-interest debts, start a business, or do anything else. But many people avoid getting a loan from family because they think it can put a strain on their relationships with them.
However, it isn’t a bad idea to borrow money from your loved ones. Clear communication about repayment, consequences, and expectations is key to running your family loan smoothly. Creating an agreement for a family loan can be a handy document that can be used as proof when needed.
What is Family Loan?
When you borrow money from a family member or loved ones, it’s called a family loan. A family loan is an easy and convenient way to borrow money from family with a low interest rate and without going through too much paper work related to the loan application. But your relationship with your family can go awry if you are not able to pay the loan payments.
A family loan is not considered a gift if your family has expectations of repayment. Before getting a family loan, you need to discuss with your family the amount of money you need, the interest rate, if any, and the repayment terms. Be aware of the tax implications that can be involved in family loans.
Create a Family Loan Agreement
Learning how to get a loan is very important before applying for one. Creating a family loan agreement is essential, even if you’re confident you will never need it. A loan agreement clearly defines your loan terms and future repayment conditions.
The IRS requires a written agreement if your loan amount exceeds $10,000. The agreement should outline the interest rate and terms of the loan, also minimum interest called the applicable federal rate (AFR). If your borrowed money is less than $10,000, you don’t need to worry about the potential tax implications.
Creating an Agreement Document
An agreement can protect you in the event of discrepancies, but it’s also essential if your loan amount is more than $10,000.
The agreement should include the following details:
• The amount to be borrowed
• The interest rate of the loan, if applicable
• The method for transferring the funds
• The amount of repayment and terms
• Steps to take in case of nonpayment, such as legal action or taking ownership of any collateral
• Additional costs, if any
• Potential modifications to the loan terms
• Signatures from both sides
If your loan amount is large or if you’re going to purchase a large asset, such as a home, it’s better to contact a legal counsel for input and to create legal documents for your safety.
The terms written in the agreement should simplify the process of the loan and help to avoid misunderstandings between both parties.
Tax Implications
The IRS requires a written agreement; if your amount is higher than $10,000, the agreement should outline the repayment and loan terms. The AFR varies based on the loan duration, and the interest rate is updated every month.
Learning about tax implications is important when you want to learn how to get a family loan. The lender can also charge a higher interest rate if they want to. However, the IRS counts interest that should have been received on a loan that exceeds $10,000 as income. If you give a loan to a family member but don’t know about the tax implications, you may find yourself in a situation where you have to pay the interest rate of the loan instead of earning interest on a five-figure loan, even if you don’t charge any interest to the borrower.
The APR is updated every month, so you need to track when and how the loan principal is repaid.
You can consider gifting the money to a family member if you don’t want to deal with the struggle of tracking interest and income liabilities. As of 2023, you can gift the amount of $17,000 to a family member without paying any gift tax.
Nonpayment
Your agreement should outline the consequences if the borrower delays or is unable to pay the monthly payments, whether temporarily or permanently. It’s important to mention that money changes hands.
Record-Keeping
Record-keeping will help you keep your family loan experience smooth. Consider using a system that allows you to see every payment transaction that you make. Simply put, you can use a pen-and-paper notebook, an online spreadsheet, or other systems to keep records of loan payments.
This will help to keep your relationships healthy with family, and it will also be beneficial to keep your finances neat and accessible if you show them to the IRS or future inheritors.
Pros and Cons of Family Loans
You and your family members are the only ones who can decide whether a family loan is good or bad for you. Before applying for a family loan, you have to know the pros and cons of family loans, which are given below:
Pros of family loans
Lower interest rate: Your family members may give you a loan with a low interest rate and better terms than a traditional loan.
Access regardless of credit: A family loan can be a good choice for you if your credit score is low and you are struggling to get approval for a traditional loan.
Negotiation is possible: In family loans, a borrower can get a potential repayment solution that can be far better than traditional loans.
Cons of Family Loans
No credit building: A family loan can’t help you build your credit history because your payments are not recorded by credit bureaus. If your goal is to build your credit history while repaying the loan amount, consider taking a personal loan, a small business loan, or a mortgage.
Potential to damage relationships: Poor communication can cause strife and resentment between the borrower and family members. Better communication is key to keeping your relationship smooth and healthy.
May need to be disclosed to the IRS: If your loan amount is higher than a certain threshold, you may need to pay additional taxes or other fees. You need to be aware of the IRS interest rate and terms.
Alternatives to Family Loans
There are some reasons why family loans are not a good option for you. But you can consider other options instead of family loans, which are given below:
Cosign
If you have a bad credit score and want to qualify for a loan, you can consider adding a cosigner to your loan. Generally, your credit score is replaced with your cosigner’s credit score. Keep in mind that your cosigner’s credit score should be good or excellent.
Adding a cosigner can help you lower your interest rate and may offer better terms. But, if you delay your payments or are unable to pay your loan payments, that can have a negative effect on your cosigner’s credit history.
Gift
If you want to help a family member without expecting repayment, you can do so by gifting them money. In that case, you don’t need to worry about income taxes, interest rates, or repaying the money. You can gift a family member up to $17,000 without worrying about gift tax. If your money amount exceeds more than $17,000, you have to pay attention to the potential tax implications.
Small business loan
If you are looking for a loan to start your own small business, you can consider using small business loans. A dedicated business loan can help you build your business’s creditworthiness. You may be able to qualify for a higher amount of funding than your family may offer. But you will get a good start on starting your own small business.
Cash advance apps
You can consider using cash advance apps to borrow up to a few hundred dollars and repay the money when you get paid again. These apps don’t charge any interest, but you need to pay subscription fees and fast funding fees. They may also ask you for a tip. If you use a cash advance app, you should have a plan to repay the money on time.
Frequently Asked Questions
How can i legally lend money from a family member?
A family might be should be made with a signed written agreement, repayment terms, and a minimum interest rate, according to the IRS.
If your loan amount is less than $10,000, you don’t need to pay interest to the IRS, but if your loan amount exceeds $10,000, you have to follow the IRS’s minimum interest rate and terms.
How much money can be legally given to a family member a loan?
If your loan amount is under $10,000, you don’t have to follow complex IRS rules. But, if your loan amount exceeds $10,000, you have to follow IRS rules regarding interest rates and repayment terms.
How do I ask my family for a personal loan?
The steps to asking for a personal loan from family are:
• Looking for decide when to ask
• Describe your financial needs to them
• Inform them how much money you require
•Tell them your plan to give back the money
Does a family loan require notarization?
Yes, it should be signed and notarized by both parties, even if you think that you don’t need to do that. The terms written in the agreement should simplify the process and protect both parties from misunderstandings in the future.