The Rules of Borrowing Money from Family

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There are a lot of reasons you might turn to your family members for loans. Perhaps credit problems
in the past have left you ineligible for other types of loans. Or maybe the terms you are being offered
aren’t very favorable (in terms of limits on funds, high interest rates, or repayment schedules that are
too stringent). And borrowing from a family member could combat all of these (at the very least, family
members may be more lenient with repayment and interest). But there are also some major drawbacks
to borrowing from your family, the worst of which could be ruined relationships or even lawsuits with
family members. So if you’re going to borrow from your family, there are a few rules that you should
implement in order to protect the interests of all so that a simple loan doesn’t end up ruining your
personal relationships.

1. Write up a loan agreement. Even if all you do is write out an IOU with the amount and sign
it, it serves as proof that you borrowed the money and you intend to pay it back. You should
probably write a more specific agreement that includes any interest to be paid, a repayment
schedule, and penalties for failure to pay, as this will protect all parties involved from false
claims down the road (who knows what people will do when they get angry over loans gone
wrong). But terms aside, making such a promise to repay in writing will help to put you in the
right mindset to treat this financial obligation like any other, despite the fact that it stems from a
personal relationship.

2. Set an interest rate. Since you will have to document this “income” on your taxes (and your
family member will have to document the expenditure), you’re going to need to set an interest
rate on the loan to ensure that it isn’t viewed as a gift instead. If the loan is seen as a gift, the
lender could be on the hook for a gift tax. Since you probably don’t want to punish the person
that is helping you out, set any interest rate, even if it’s a negligible amount.

3. Set a payment schedule. Because you enjoy a close relationship with your family members,
it’s all too easy to take them for granted and make good on other financial obligations at their
expense. For this reason, it is important to set a schedule for payments, just like you would with
any other lender, to ensure that your generous family members don’t end up with the short end
of the stick.

4. Get a witness. In order to ensure that your agreement or contract is legal and binding you need
to have a witness. So find yourself a notary public in your corporate office, at your bank, or at a
UPS store to act as an unbiased, third-party witness to the agreement in order to set the deal in
stone.

5. Consider other options. While bank loans, unsecured loans, and payday loans may not come
with very appealing terms, they definitely won’t end with your family members un-friending
you on Facebook and refusing to take your calls. So if you’re at all worried about the potential
damage that could be done to your personal relationships as a result of borrowing money,
simply go with a lender that doesn’t know you personally.