The Basics of Lending to Friends and Family
If you’re thinking of lending money to a friend or family member, whether it’s to help them save on interest payments for a house, car, college tuition or—like most borrowers from friends and family—to consolidate debt, here are a few measures that could reduce the likelihood of money getting in the way of your relationship.
Set a Rate
It may be a gamble to lend money to someone who might not be qualified to get it from another source, so charging interest for loans to friends and family isn’t unreasonable. In fact, it might even be necessary.
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Although you might feel uncomfortable taking money from family or friends, especially when you’re generous enough to be a lender, let’s face it: Your money could be safer in a savings account, and lending without charging interest actually amounts to giving more than just the principal.
And if you’re lending more than $13,000 as of the beginning of this year, your “loan” could be treated, for tax purposes, as a gift subject to a tax that you, the lender, have to pay. To ensure your contribution will not be considered a gift, you’ll have to charge your borrower an interest rate that’s at least the applicable federal rate established by the IRS, which for April ranges from 0.83% to 4.7% depending on the duration of the loan.
And if you really need convincing to consider a loan to a friend a worthy investment, you can propose an interest rate that’s lower than your friend’s other possible sources of credit, but higher than what you’d accrue from a savings account.
“There’s certainly a risk. If they can’t borrow from a traditional source, there’s a higher likelihood for default,” says Gerri Detweiler, a credit advisor at Credit.com and author of Reduce Debt, Reduce Stress. Detweiler says you might want to consider how you’d feel if your friend or family were to default. Would you consider the loan a gift, or would you take them to court?
