A family loan agreement documents the amount borrowed and repayment terms agreed upon by the lender and the borrower. This legal document safeguards the lender’s interests and ensures both parties are clear on the expectation of repayments. Create your family loan agreement template in minutes and save a complete PDF document to your device for convenience.
We always feel compassion when it comes to helping with finances for our family members. It’s quite common to lend money to close people. However, you also need to pay attention to the important things that can be ensured with a family loan agreement.
What Is a Family Loan Agreement?
Lending money to a family member is one way of uplifting other people in the family with limited financial resources. You get the satisfaction of helping, and the borrower receives the finances they need at the moment. A family loan agreement documents the amount borrowed and repayment terms agreed upon by the lender and the borrower.
Benefits of Using a Family Loan Agreement
Much can be taken for granted when money is exchanged between family members. Details such as the expectation and repayment terms may cause tension in the family if not clearly outlined. A family loan agreement safeguards the lender’s interests and ensures both parties are clear on the expectation of repayments. Other benefits of having a loan agreement include:
Avoiding potential disputes and litigation;
Minimizing instances of miscommunication and misunderstandings; and
Documenting the terms of the agreement.
What To Consider Before Loaning From a Family Member
You may hesitate to pursue aggressive collection actions against a family member since it may strain your relationship with the borrower and the wider family. Besides thinking through the impact lending the money will have on the family, consider whether you will still be financially buoyant if the borrower fails to pay back the money, or extends the repayment duration. Assuming that the borrower may not repay the loan or may take an inordinately long time to repay will help you consider your options regarding extending the loan and the repayment arrangements in a more realistic light.
Using a Family Loan Agreement
A family loan agreement is legally binding between a lender and a borrower related by blood or marriage. For it to be effective, it should cover the following issues:
The loan amount;
The names of the parties;
The repayment schedule;
The rate of interest;
The remedies and contingencies;
The governing law;
The witnesses; and
Before you enter into a legally binding contract with the borrower, consider the following steps.
Analyze the Family Member
Before you lend money to a family member, it is prudent to ask yourself the following questions:
How will the borrower spend the money?
Have they asked you for money in the past?
If yes, did they repay promptly?
Would you say that the borrower has reasonable financial management skills?
Are they currently in debt?
Do they pay bills on time, as far as you can tell?
What sort of liabilities do they have?
Check also the credit score and credit report of the borrower. If you find that their credit history is wanting, consider if you can give the asked amount or a fraction of it as a gift.
Formalize an Agreement
Discuss with the borrower the terms of the loan. Each should identify and reach out to preferred witnesses to the contract and select a date for signing.
Finalize and Sign
In the presence of two witnesses and a notary public who can verify the authenticity of the signatures and sign the loan agreement. After signing the contract, disburse the funds to the borrower through an electronic means or check. Documenting the disbursement of the funds helps avoid situations where the borrower may deny receiving the money.
How To Lend to Family
When extending loan funds to a family member, always consider lending what you’d be comfortable giving without being constrained if you are not paid back. Due to familial relationships, your borrower may not take the loan as seriously as they would if they were borrowing from a bank or credit union. However, having a loan agreement will demonstrate your seriousness in expecting repayment. Consider making the repayment terms flexible so the borrower can be consistent.
How Much Money Can You Loan a Family Member?
The amount of money you can lend to a family member is dependent on your risk tolerance. Think of extending the loan as a business decision and only loan out what you can afford to lose.
What Is the Minimum Interest Rate for a Family Loan?
The minimum interest rate for a family loan as of April 2022 is 2.2 percent. Every month, theInternal Revenue Service(IRS) publishesApplicable Federal Rates(AFRs) that should be charged to family loans. According to the federal government, the borrower is likely to use the money given as a loan without interest to earn more money.
Therefore, the IRS requires a minimum interest rate for family loans of $10,000 and above to limit instances where people use family loans to reduce their taxable income legally. Suppose the loan is interest-free, then IRS will consider the interest to be charged as income to the lender from the borrower. The IRS expects the lender to report the imputed income subject to social security tax.
Family Lending vs. Bank Lending
Family lending may have advantages, especially when a borrower cannot secure banking or traditional borrowing due to spotty credit history or urgency. Administrative lawyers and bureaucracy among formal lending institutions may mean waiting days, weeks, or months before a loan facility is approved.
But creditworthy assessment for a loan to a family member is based mainly on the relationship between the parties. Even with a bad credit history, a family member may be willing to take the risk and offer a helping hand. Family loans are cheaper than commercial loans, with administrative costs, appraisal fees, closing costs, and higher interests. Family loans can be a means for a family to maintain savings based on interests and expenses retained within the family instead of paying them to a bank. However, family lending may not be sustainable as a long-term financing solution. Use the option to recover from a less-creditworthy score or situations where money is needed urgently.
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Frequently Asked Questions
What should be in a family loan agreement?
A family loan agreement is a legally binding document between a lender and a borrower related by blood or marriage. The agreement indicates the amount given as a loan to the borrower and the terms for repayment.
How do you write a family promissory note?
A family promissory note should contain the following details:
The amount loaned;
The details of the borrower and the lender;
The date when the loan is issued;
The repayment schedule including the dates, the amount of each repayment amount, and interest charged; and
Penalties for default.
How do I report a family loan to the IRS?
First, document the loan according to the steps and aspects provided in this article. Secondly, consider charging the monthly AFR interest if the amount exceeds the $10,000IRS taxable minimum to avoid tax complexities. According to the loan agreement, you should report the earned interests paid to you as the lender as taxable income for each repayment period.