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What Is a Family Loan?

Family loans are informal arrangements without a contract or interest.
Young families facing financial challenges may seek to borrow money from relatives rather than a bank.
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  • Originally Written By: Tricia Ellis-Christensen
  • Revised By: Wanda Marie Thibodeaux
  • Edited By: O. Wallace
  • Last Modified Date: 15 September 2014
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A family loan is a financial debt a person owes to a relative. In the majority of cases, the agreement is extremely informal with no contract or interest, which can create problems with repayment. The line between borrowing and gifting sometimes becomes blurred, with some experts even recommending that the lender simply not expect his money back. From the tax perspective, the debt typically isn’t complicated, but the relationship strain it can cause is reason to approach this method with some caution.

How It Works

Under this type of lending agreement, a person goes to a relative for money instead of to a bank or similar company. The degree of blood relationship is not particularly important, but the relationship is usually close enough that both people feel comfortable working on financial issues together. In most cases, the agreement is very informal and not written down, with the borrower repaying without interest.

Reasons for Use

People often borrow from family members because it requires less work than going to a bank. Standard procedures financial companies use, such as checking a person’s credit, almost always are left out of the equation. Additionally, sometimes people want the money for something a bank might see as unnecessary, silly or too risky. Most relatives don’t charge interest, so getting money this way is often the cheapest option. Individuals also often look to family members when their credit is poor enough to eliminate more formal options.

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Repayment

A major problem with this type of debt is that the people involved often fail to spell out the terms for repayment in a concrete way. The lender assumes that, because the borrower is a relative, and because “life happens” to throw plans off, it’s not nice or necessary to strictly define how or when repayment will happen. In fact, the general motto usually is, “He’ll pay it when he can.” Similarly, the one receiving the money typically believes that it’s fine to make payments that are late or lower than planned because the relative giving the loan will “understand” difficulties or simply won’t care how or when he gets the funds back.

Taking this kind of approach to repayment can create additional financial and planning issues. The person who gets the money typically doesn’t include the loan repayments in his monthly budget, making it hard to be consistent. The individual providing the cash cannot commit it to anything in the future, because he cannot count on getting payments as expected.

Repayment is usually better when the borrower looks past his relationship to the lender and views him in the same light as a bank, credit union or similar business. He should be reasonably certain that he can stick to a payment plan and an agreed upon payment amount. If a person thinks he won't be able to meet his obligations, he might want to ask for a gift instead, or not ask for the money altogether.

Contract Use

Due to the problems a lack of a clearly defined repayment plan sometimes creates, experts recommend that people put a serious spin on family loans by creating a formal contract. This document doesn’t need to be especially complex; it just needs to outline basic terms and explain what consequences, if any, will be enforced if the money remains unpaid. The names of everyone involved and their contact information should be on the agreement, as should their signatures and the date of signing. Many websites have downloadable templates available if a person doesn’t want to create one from scratch.

A major advantage of using a contract with a family loan is that, if the lender has to sue in order to get his money back, there is a record of the obligation to pay. Judges use the document along with any payment records that might exist to come up with a judgment amount. Verbal agreements do have legal standing, but without hard evidence, the judge has to rely more on his gut or instincts, and the likelihood of the lender getting a favorable outcome goes down.

Assigning a Gift Label

For some people, it’s easier to consider the money a gift, rather than to worry about setting strict repayment conditions or working out a contract. With this method, the lender assumes that the borrower won’t pay on schedule, will pay in varying amounts or won’t give any of the cash back at all. This makes some sense considering that, unlike when a person goes through a bank, no loan insurance is available in these kinds of agreements. It also means that the lender only gives the money if he can afford to lose it.

Tax Considerations

In the US, a loan of less than $10,000 US Dollars (USD) does not have any tax obligations. A person can consider up to this amount per year a "gift" without paying gift taxes. The Internal Revenue Service only counts the interest earned as taxable income. Most people don’t need to worry about this, because unlike banks, relatives typically don’t bother to charge anything for the privilege of getting the cash.

When a family loan exceeds $10,000 USD, the situation can become less clear. To avoid paying a gift tax, people need to claim the money provided, but the IRS may assign the person an interest rate that they expect him to collect as "income." To avoid this, the lender may want to consult a good tax attorney or accountant to make sure the terms of the debt are clear, especially if no interest is being charged.

A lender also can claim unpaid amounts that will never be paid as a tax loss. Sometimes, the IRS will try to collect taxes from the borrower if the money technically becomes a gift due to nonpayment, however. This may be a more reasonable step than having to sue, but it's still a little complicated and may be best managed by a tax professional.

Relationship Strain

Failure to repay a debt of this kind can strain family relationships, even if those connections have been excellent in the past. The lender might feel offended and cheated if he doesn’t get his money, while the borrower typically doesn’t like being under financial watch. Conflict easily can spread to relatives not involved in the agreement, because they often feel obligated to defend one side or the other when problems come up.

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Discuss this Article

anon944144
Post 46

If my sister borrowed money from me three or four years ago, and she died recently, is that money still due to me from her estate? We never did any type of "contract" but I do have a copy of the check(s) I wrote her saying "loan" on it. The total amount is under $10K. How strong will this hold up in probate in order for me to get the money I'm owed back?

virginiamary
Post 43

My sister loaned me $7000 six and a half years ago to help me pay off my lawyer in a legal action that she urged me to do.

Meanwhile, we took her and her infant daughter into our home, as she had nowhere to go at the time, out of compassion. We thought that she might stay a year or two, until she "got back on her feet". Instead, she stayed with us that entire time, paying nothing for room and board.

After saying nothing about the loan for six and a half years, on the day she was moving out, she informed me that I owed her that money. I guess she didn't want to say anything about it while we were still supporting her. I had forgotten all about the loan at that point.

My question is: Given that we provided room and board to her for all that time, can that be considered as payment in kind? If she had paid us rent all that time, our support would have far surpassed the amount of the loan.

There is no promissory note or repayment plan. She has a copy of the check she gave me. At the time, she said, "pay me when you can". Now she is demanding that we pay her $300/month. Am I liable for this?

anon357768
Post 37

@Tracey50: "No written agreement" is your out, here. Your father can *say* whatever he wants, but you've paid the principal of the loan and the $6,000 interest was basically a courtesy on your part, anyway.

You may want to consult an attorney to be certain, but without a written agreement, I don't think this is enforceable.

Besides: the last $5,000 you paid, if not touched, has earned a considerable amount of interest over the past 19 years in its own right. But see a lawyer to be sure of your ground.

Tracey50
Post 36

Some 25 years ago, my father loaned me $15,000 for a deposit on our house and this included a charge of $6,000 for interest, making the total loan $21,000.

I paid him the initial loan of $15,000 over a period of five years, with the last payment in a bulk sum of $5,000. That was made 19 years ago. There was no written agreement and he has a detailed list of the payments made that I have sent him over the years. I never paid the interest of $6,000 and he never asked about it over this period and we have never discussed this. Due to other reasons, my father and I have not spoken for the past 15 years. Anyway, a few months ago I received a letter from him demanding his money; otherwise he would go to his lawyer to put a hold on my house and recover his money.

In his letter to me, he puts the outstanding figure is now just over $35,000 - the original $6,000 plus he has added interest on the interest. This demand comes 19 years after my last known payment to him.

I am prepared to pay him his $6,000 and have started to make payments of $100 per week, with the balance now at $4,500. Can he legally make me pay him that $35,000? He has threatened court action. If this went to court would I be made to pay the $35,000 plus? Thanks to anyone who can help.

anon355472
Post 33
anon348305
Post 27

My parents borrowed $23,000 from me through a verbal agreement. I was wondering if I could sue them and where or how should I start?

famloan
Post 20

I may need about $200,000 for a short period (July through September) in order to fund an investment opportunity -- at which point I will be able to obtain the cash on my own. My brother has this money (currently invested in a standard S&P 500 index stock fund) and he is willing and able to lend it to me for that period. My plan would be to return it to him (along with whatever additional amount he would have earned in interest if he had kept in the stock fund) in September.

Is it necessary to report any of this to the IRS as either a gift or a family loan (and if so, as which of the two) when we file our respective returns on 2013? (Technically the $200,000 is not a gift because he'll be giving it to me, then I'll be giving it right back to him within the same year. And the amount above $200,000 that I'd be giving him (which is unlikely to top the $13,000 max for a gift that does not to be reported) could be considered a gift from me to him, since we're happy to just agree to that without a binding legal document.

If it is legal, I'd prefer to go the non-reporting route because that way we don't erode the lifetime gift tally (which would be unfair since this is not a gift), and similarly I'd prefer not to declare it as a loan because then he has to go through the rigamarole of including it on his tax return all for a two-month "loan". My understanding, by the way, is that if this is the avenue we are legally required to pursue, we can set the agreed upon interest rate at the much lower federal minimum and he pays taxes on that, but I can then gift him any additional amount (below the $13,000 limit) in gratitude to him, but not officially as some legally required interest.

We are very close and have total confidence in each other's trustworthiness on financial commitments so ensuring follow through is not an issue.

anon277693
Post 13

Can parents loan their adult child money to invest in the stock market? Would that be considered a "gift" or a "loan" or something else, as far as taxes go?

anon277692
Post 12

My father has been blessed to be financially successful and wishes to give me, his son, some of his money.

I realize that father can give $13,000 tax free and my mother can give $13,000 tax free, or $26,000 combined.

Is there a way to give more without incurring a tax penalty?

anon155730
Post 7

I got a loan from the bank $500k to purchase my PPOR back in 2007. Out of the $500k, $400k was variable and $100k fixed rate.

Between then and now, I've paid out the fixed rate loan and brought the balance of the variable loan down to $10k. The majority of the funds used to reduce the loan down were from borrowed funds from my dad($450,000). Dad loaned the $450,000 interest free and I am to pay him back in the near future.

Now, I am looking to make my PPOR an investment property and plan to draw the loan back up to repay my dad. Can I draw available funds in the variable loan back up to it's limit + borrow more funds from the bank to repay my dad?

Also, with the property now being an investment property, can i claim interest on the full $450k? The $450k that I draw from the bank will be paid into my dad's Savings account.

Please advise if this ok with the ATO and what supporting documents is needed.

anon123363
Post 6

My granddaughter has borrowed a significant amount of money from me over the last five years. I even took out a loan in my name for her.

I haven't had her sign anything or had any contracts drawn up. Everything I've borrowed has been in my name and now she's defaulting on payment. Is there any way to recoup some of my money and if I sue her would I be able to get any money from her that way without a written note?

anon89684
Post 4

No, her parents and you took total liability on the house. If you put 80,000 down and you lost 50,000 of that, leaving 20,000 25% of the original amount. Then you take .25 * (50,000-what you already paid back) and 25 percent of 30,000 and split it. So you get 7.5k and they get what they get probably closer to 11k.

guskyle
Post 3

den12: (1) All $20,000 of the equity should go back to your ex-girlfriend's parents.

(2) Let them sue you for the rest.

(3) You made many big mistakes (no initial written agreement; buying a house with your girlfriend; believing that paying rent is like throwing your money away; believing that house values always go up; etc.) -- don't ever get into a messy situation like this again. You learn 10 times as much from mistakes as you do from non-mistakes. Consider this a $20,000 learning experience.

den12
Post 1

I bought a house with my ex-girlfriend. I put in $30,000 of my money and she put in $50,000. Her $50,000 was a loan from her parents. We agreed to give her parents $400 per month and once/it we sell the house we were to pay them back whats left. It was not till 3 months ago I actually signed a piece of paper stating this. The house is now selling, but, we will only have about $20,000 of equity. How does it get split up, and how can we pay the parents off if there is no money left (not enough after the sale)?? Am I on the hook to pay them back in full??

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