A Primer on Loans Between Friends and Family Members
The Federal Reserve Board Survey of Consumer Finances estimates that loan transactions between friends and relatives amount to $89 billion per year in the United States. These loans play an important role in our economy and in the lives of the participants as the funds involved are often used to start new businesses, purchase homes or other assets and to assist with unexpected events like a sudden illness or job loss.
Should you say yes or no to becoming a part of the statistic above? This primer can’t decide that for you, however, if you do say yes there are a number of considerations and procedures that are important to follow. Without these in place, money can do strange things to otherwise healthy relationships, especially if the transaction does not work out as originally intended.
We note an excellent article from Debt.org (https://www.debt.org/credit/loans/friends-family/) that covers all of the basics. A written loan contract that specifies the terms is essential, but don’t forget to plan for the less obvious items such as what happens in the event of default, setting communication expectations and managing the tax implications of a loan (which can include income and gift taxes).
The Debt.org article contains valuable advice for those that may become a lender. Questions to ask yourself before making a loan include:
Would I be willing to foreclose on the borrower or sue if they default?
Would I be willing to become personally involved in the borrowers business or project if necessary to guarantee repayment?
Why am I being asked to serve as the bank?The article details several alternative sources of financing for those that decide against making a loan to a friend or family member. The Small Business Association offers many options for business loans and peer-to-peer lending platforms may also provide a viable option.
Before you take the plunge, here is a great article from Quicken.com (http://quickbooks.intuit.com/r/loans/pros-and-cons-of-accepting-loans-from-friends-and-family/) that debates the pros and cons. Don’t forget that unlike a banker, friends and family tend to see one another regularly and the dynamics of those interactions will often change with the existence of a loan. Good advice for dealing with this is included.
If you do move forward, consider using technology to help manage the administrative pieces of a loan. There are many online resources available to help with loan documents, amortization schedules, etc. Some of these will even prepare tax reporting forms and send payment notices. A few of these sites are noted below.
As noted above, loans to family and friends are big business. So big in fact, that they approximate the estimated net worth of Bill Gates each year! We hope that this information is helpful to those that are considering the role of lender or borrower with their friends or family members.