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How to Make a Family Loan Agreement (with Template)
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Learn More About Family Loans
When family members loan other family members money, it can be referred to as a family loan. If you have considered offering loans to family members, you have probably toggled between the pros and cons. While it may help your family members in need or save them from high interest rates, it can cause conflict and unwanted family drama as well. Let’s take a look at some of the things you should consider before giving or receiving a family loan.
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How much money can you loan a family member?There usually aren’t limits on how much you can extend to a family member as a loan. However, you should consider tax rules that might affect your financial position and how much your family member can comfortably afford as loan payments. In addition, you’ll want to make sure you don’t lend money you might need for yourself. It’s important to follow the tax rules that apply to your situation to avoid problems with the IRS.
Can you lend money to your family?That said, you can definitely loan money to a family member if you want to. You can also give them a gift but sometimes you need the money back. If it’s a loan, an agreement should be drawn up outlining the details. The agreement should include the interest rate, payment terms, how long the borrower has to repay the loan, and other details that will be described further in this blog.
Sometimes lending money to family members can complicate relationships. Borrowing money from relatives can sometimes make those holiday gatherings uncomfortable. To avoid mixing family and finances, you may want to consider other options first. One option you may qualify for is a personal loan. To find out if you qualify for a personal loan you can get pre-qualified offers at Acorn Finance with no impact to your credit score. If you do end up using a family loan, and you are in the position of the lender, make sure to only loan money that you do not actually need back.
How do I set up a family loan?Here are some steps to take to set up a family loan:
Make sure you are in a position to fund a family loan. If it will make things tight financially, just say “no.”
Consider the borrower’s income and repayment history. If they have a history of not repaying their debts things probably won’t be any different this time.
Get a loan agreement drawn up after terms have been agreed upon verbally. There is a minimum interest rate for family loans set by the Internal Revenue Service (IRS). The rate is the Applicable Federal Rate (AFR). To avoid getting into hot water with the IRS you’ll need to charge at least the AFR on the money you loan. An exception to this is if the loan is less than 10k. The IRS doesn’t really worry much about loans of that amount or less.
Does the IRS require interest on family loans?If you have been researching family loans, you may be wondering which AFR rate to use for family loans. Let’s say the loan amount is more than 10k. The lucky recipient of the funds will need to pay at least the AFR. Fortunately, rates are really low right now so that shouldn’t be all that bad. When figuring out which AFR to use for a family loan you will need to determine how long the borrower has to repay the loan. The AFR can change from month to month. The rate depends on how often interest is charged and how long the term of the loan is. The three different time periods: 3 years or less, 3-9 years, and more than 9 years. As of July 2021, the AFR has a range of .12%-2.07%. Sounds reasonable, right?
Can a family member lend me money to buy a house?With rates as low as these, wouldn’t it be great if you could borrow money from family for a mortgage? The good news is…you can! You can borrow the down payment subject to tax rules or borrow the whole amount. The whole amount would be set up as a private mortgage by a lawyer between you and the family member who is lending you the money.
What is the minimum interest rate for a family loan 2021?Suppose you are going to borrow money to buy a house or for another purpose from a family member. If the loan is over 10k, the IRS has a minimum rate you must charge which is the AFR. Rates are posted on their website and vary from month to month and by the term of the loan. Although you have to legally charge interest on a family loan, the minimum is very low right now. The lender can charge more if they want to but it is not required for tax purposes. Check online to see what the current minimum rates are.
Do I pay tax on a family loan?Since the lender has to charge interest on a family loan it makes sense to ask if you need to pay tax on it. Interest is typically reported as income for the lender. Whether you, as a lender, need to pay tax on it depends on your tax situation. If you’re the borrower, you don’t need to pay tax on it, in fact you might be able to deduct it depending on what the loan is used for.
A financial advisor or accountant can look at your unique situation to help you with this. While a family loan may sound ideal, it’s not always. It can require a lot of research and time from the lender and the borrower. Using an alternative option such as a personal loan may reduce stress and keep business out of your family relationships.
Can my parents give me $100,000?A financial advisor or tax professional can help you with the tax implications of gifting money to your child. Rather than go through setting up a loan, dealing with collecting payments and the IRS, some people prefer to give their children the money as a gift. So what happens then? Well, individuals have an annual and a lifetime gift amount. A gift of $100,000 will exceed the annual gift amount but not the annual lifetime gift amount. Your parents need to fill out the appropriate tax forms for the IRS to have $100,000 deducted from the lifetime gift amount.
Can I give my son or daughter an interest-free loan?Some people don’t want to give their child a gift, but don’t want to charge interest on the money they loan. If they have to pay interest they could just go to a lender, right? There is also the thought that if interest is not charged they can avoid the IRS. Well, you can and you can’t. You can lend the money interest free. If it is less than 10k the IRS doesn’t bother with whether or not you charge interest. If it is more than 10k, the IRS can ascribe the interest to you anyway at the prescribed rate so you will have it added to your income whether you received it or not. There are further tax implications to an interest free loan over 10k to a family member so it is wise to check with a tax professional before proceeding.
Do family loans show up on credit reports?Before lending or borrowing money, people want to know if it will impact their credit report. Family loans don’t show up on credit reports. This can be good or not good. You get no benefit on your credit report for being a reliable borrower and you are not penalized if you don’t make your payments.
How do you borrow money from a family member?Well, depending on your relationship, you borrow it carefully. Borrowing from a family member can be awkward. First, you’ll need to find a family member willing and able to loan the money. Next you’ll need them to agree to terms. Regardless of how much you trust a family member you should always sign an agreement that clearly states the terms.
Can I loan my son or daughter money to buy a house?You can use the steps we already mentioned to lend your son or daughter money to buy a house. Whether you are loaning a downpayment or the full amount you will need to charge at least the AFR for interest of the amount exceeds 10k. You might need to involve a lawyer to draw up documents for a private mortgage or even to put a lien on the house for the amount of the down payment. Your lawyer will put all the necessary details in place.
Loans to family members can make sense but there are legal, tax, and relationship implications. Family loans can offer extremely low interest rates and customized terms. However, family loans can cause a lot of friction and bad feelings especially if the borrower doesn’t repay the loan.
If you loan to one family member, others might approach you for money as well. If you or a family member wants to borrow money and keep their finances separate from their family relationships, you should consider using a personal loan.
Acorn Finance has trustworthy lending partners that can offer personal loans with APRs as low as 6.99% depending on your credit score. Individuals can discover simple and competitive payment options through Acorn Finance. At Acorn Finance, you can submit one application and receive loan offers in 60 seconds or less with no impact to your credit score. Once you have claimed the best offer and finalized the loan, you can receive funds quickly.
Trying to avoid a family loan? Check personal loan offers with no impact to your credit score!
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