Lending To Family?
Your daughter needs money for a down payment on a house. Your brother is out of work and can’t pay the rent. Lending to family is fraught wIth dangers. But If you must consIder It, do 6 thIngs fIrst.
Your daughter needs money for a down payment on a house. Your brother is out of work and can’t pay the rent. Or your aging parents are struggling with their finances.
When someone in your family asks to borrow money, you naturally want to help if you can. But beware: Lending to relatives can cause misunderstandings that strain even the strongest relationships. Unsettled debts may produce resentment on your part—or even guilt-fueled unhappiness on the part of the person you’re helping. And other family members may become jealous when they see a relative getting what they perceive as a “handout.”
“It’s a good rule never to lend money to a family member, just as it is never to go into business with one,” says Maria Plucinsky, a certified public accountant with the Hunter Group in Fair Lawn, who has seen her share of family squabbles over money. “but in the real world, you sometimes have to break this rule. If you must, do so very carefully.”
Before you agree to lend to a relative:
1. Assess Your Financial Health
Take stock of your finances realistically, says Plucinsky, to see if you can afford to lend the requested amount. Don’t let your thinking be distorted by ego, generosity or the desire to be a hero. The sad fact is that there’s a significant chance you won’t see this money again, so don’t tap into a retirement fund or a dedicated college account. “It really has to be money you can part with,” says the CPA.
2. Assess The Family Member's Need
What is the loan to be used for? A final semester’s progress toward a college degree? That could be worthy. A trip to Graceland? Maybe not so much. To be blunt, consider whether the loan may be squandered, taking into account relevant issues such as any known experience on the borrower’s part with drug or alcohol dependency, an erratic employment pattern or already unsustainable levels of debt.
3. Consider Your Family's Dynamic
For example, if you have two sons and lend money to one, the other could become jealous even if he’s successful and self-sufficient. “You have to be willing to deal with these issues,” Plucinsky says.
4. Consider Your Family's Dynamic
Once you agree to lend money, establish specific terms with the borrower, including the amount and a clearly defined payment plan. “If you just say, ‘Pay me back whenever,’ it won’t work,” Plucinsky says. “The more structured the loan can be, the better.”
5. Set An Interest Rate
It sounds callous, but North Haledon-based CPA Douglas Hoogerhyde says that with documented loans, particularly large ones, the Internal Revenue Service may assume you’re collecting interest and try to tax you on that income—whether or not you’re actually receiving it. So charge at least a minimal interest rate—between 3 percent and 4 percent based on today’s economy.
6. Put It In Writing
Draw up a document listing the terms of the loan, sign it and have the borrower sign. You can hire a tax or financial adviser to help draft the contract. Too often, experts say, financial agreements within families turn into battles because people either won’t agree to documentation or don’t understand its necessity. “Many people think a family loan can be done with just a handshake, but that spells trouble,” says Hoogerhyde.
Documenting a loan also can avoid tax problems. Plucinsky says the IRS could perceive a substantial undocumented loan as a gift, which under some circumstances could raise your taxes. However, if the person you’re helping is an adult child, you may wish to consider simply giving a financial gift rather than making a loan. That would spare you the task of setting up and enforcing terms, and under current tax laws, Hoogerhyde says, each parent can give an undocumented gift of up to $14,000 per year to each son or daughter without penalty or the need to report it. —Pete Kelly
