Lending money to friends or family is a tricky business. It can lead to bad feelings and worse. In fact, you might even end up in court if things go sideways. So, before you decide should you lend family members money, take into consideration these pros and cons.
Should You Lend Family Members Money
There are some big pros and cons when it comes to lending your family members money.
Let’s take a look at the cons first.
Cons of Lending Family Members Money
There are several serious cons of lending money to friends or family.
Let’s get them out of the way before we look at the pros.
1. They Don’t Pay the Money Back
Chances are your family member or friend will have good intentions when borrowing money from you. They will plan on paying it back, but what if they can’t?
Even with the best intentions, things happen. And if this person is in the position of needing to borrow money from a family member, bad luck or money mismanagement might be normal for them.
So, give this some thought.
Are they always short on cash? Is this a pattern? If so, you might not want to lend them money as there is a good chance they won’t pay it back.
2. Your Relationship is Damaged
So, the worst happens and your family member can’t repay the loan.
Are you going to take them to court?
When it comes to giving money to family, you are putting yourself in a position where your relationship can be severely damaged.
If they don’t pay you back, you might start feeling resentful.
If you take action to get the money back – going to court – or even bugging them about the money, both of you will feel bad and tensions can get pretty high quickly.
If you don’t want to make holiday meals unbearable it might be best to not loan your family member money.
It is true, they might not be happy about that either, but it is better than the alternative.
3. There can Be Tax Consequences
Whether or not you charge your friend or family member interest on this loan, the IRS will expect you to pay tax on the interest you do receive or the interest they feel you should have received.
These are called imputed interest charges.
Not to mention, depending on your loan terms, if you have any, this money can be seen as a gift by the IRS especially if it isn’t paid back. There are additional tax rules for gifts.
There can be other tax consequences of lending money as well.
4. It Won’t Help Their Credit Score
Your friend or family member who is receiving the money will not receive any increase in their credit score for making monthly payments on time unless you report each monthly payment to all three credit bureaus.
Chances are you won’t want to have to do that.
If the loan comes from a more traditional source such as personal loans, then it will help their score as long as they make timely payments.
5. Your Whole Family Starts to See You as a Lender
If you loan money to one family member then your whole family might start seeing you as a lender that they can tap whenever they need extra cash.
This is especially true if you have a good salary and make more money than other members of your family.
A family loan is great to help out someone you love that is in need, but you don’t want it to become a situation where everyone is looking to you for cash.
6. You Can’t Use it For a Downpayment on a House
A credit union and most banks won’t accept a loan from a family member as a downpayment.
You would have to gift the money and not expect it to be repaid.
Keep this in mind if you are giving money to a family member and they want to use it as a downpayment.
Pros to Lending Money to Family Members
No one likes to be a Debbie Downer, so now that we have all the negative consequences out of the way, let’s look at the upside.
1. You Can Help a Family Member Out of a Rough Spot
Everyone can find themselves in a bad situation through no fault of their own. They get laid off from work, or have a health issue and fall behind on their bills.
If this is the case, it can mean the world to them if you can step in and help out.
This loan can be the difference between homelessness and having the time to get back on their feet.
Money from family might be much easier for them to obtain than going to a bank or getting a personal loan.
2. Lower Interest Rates for Your Family Member
A loan between family members is typically going to have a much lower interest rate than through a traditional lender.
In fact, you might not even decide to charge them interest.
Either way, this will save money for your loved one.
If you decide to charge interest, don’t go overboard. Use a minimum interest rate that is fair for both of you.
3. Credit History is Not an Issue
If your family member has bad credit, they won’t be able to get a traditional loan.
By loaning them money, you will help them out and they won’t have to worry about being rejected.
Your money might be their only option.
4. You Might Need to Borrow Money at Some Point
Let’s face it. You never know what is going to happen to you in the future.
You might be riding high now, but the day could come that you would need to borrow money from a family member.
If you turned down someone in the past, your family might be less willing to loan you money now.
Loans between family members do have some downsides, but it is a nice feeling with you can help out.
What to Do Before You Make the Loan
Before you loan money give these items some consideration.
1. Decide if You will Charge Interest
As mentioned above, you need to decide what interest rate you will charge or if you will charge interest at all.
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2. Decide on Your Loan Terms
Determine your loan terms.
When do you want the money paid back?
How much should the monthly payments be?
How long of a loan term will you give?
What’s your repayment schedule?
3. Can You Live With it If The Money is Not Returned?
Give some serious thought to how you are going to feel and whether or not you will be put into a difficult financial situation if you don’t get the money back.
In other words, don’t loan money you can’t afford to lose.
Personally, I’ve always thought it was best to think of the money as a gift. Then you don’t expect to be paid back. It makes life easier for everyone involved.
Of course, if it is a large amount of money this might not be possible, but it is something to think about.
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To Sum it All Up:
Lending money to a family member comes with a lot of pros and cons. You need to look at the situation from all angles before you decide whether or not to make the loan. There are some upsides, but the downsides are pretty darn big.