An Overview of Family Loans

A family loan can help provide you with the financing you need for an emergency, and your family member may even extend the loan with excellent financing terms. Family loans have been in existence for longer than banks; however, only recently have family members begun to pay close attention to the legal implications of the debts. If you are considering making or taking a family loan, know what you are getting yourself into and talk to a loan professional before exchanging any money.

For Lenders

When you loan money to a family member, you may think it is up to you whether you would like to take a security deposit or collateral or even charge interest. However, if you extend a loan larger than $10,000, the government may get involved. Typically, you will be required to charge interest on a loan this size, and the interest will count as taxable income to you. Since you are required to file this paperwork, you will need a legally binding contract with the borrower to ensure you are not unknowingly committing tax fraud. Further, this document will be the sole means of protection if the loan does not go as expected. Beyond legal considerations, it is important to loan only what you can afford and to make sure you can manage your personal finances after extending the debt.

For Borrowers

Family loans offer great convenience because they do not often require a down payment or credit check. This convenience, though, can come at the consequence of a smart financial decision. Make sure you are protecting yourself from harm should the relationship you have with the family member change in the future. For example, create a contract that provides for a maturity date you can financially handle. If the lender needs the money before that date, the lender has no more right to demand payment than a bank would in the same situation. This document is your only protection if the loan were to ever go to court for any reason.

Drafting a Formal Agreement

If you do not want to draft an actual loan document, you are not required to do so. However, you should still get the details of your agreement in a written document signed by both parties and witnesses and/or a notary. This document should include the following information:

  • Sum borrowed
  • Repayment terms
  • Interest (if any)
  • Obligation of both parties while the loan is active
  • Steps to close the loan
  • Any collateral placed on the loan
  • Steps to prepay or otherwise change the terms of the loan
  • Steps that would occur in a default scenario

Draft up the document with both parties present, and compare the terms to a loan available at a bank or standard lender. These lenders will cue you in to important trends in the lending market, such as high interest rates due to high inflation. Once both parties are satisfied with the agreement, they will sign and retain copies of the agreement. If necessary, it can be filed with the County Registrar, but this step is typically necessary only if collateral is used. 

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