To loan money to family members or not, that is the question. Some say any money “lent” should be considered a gift since things get sticky when you combine money and family and the likelihood of ever seeing the money again is slim. If you are going to legitimately loan money to family members, keep the following in mind.
- Figure out what you can truly afford. Before saying yes to a loan, figure out if you can afford to lose the money that is meant for a loan. Don’t put your own financial security in jeopardy.
- Make sure your spouse/significant other is on board. This should go without saying that if you are married or share accounts with another person, both should be on board to make the loan. This will help save your finances and marriage/relationship.
- Charge interest. If you don’t want the loan to be potentially re-categorized as a gift, the IRS will want to see interest charged, at least at the applicable federal rate. As of August 2017 this rate is set at 1.29% short-term loans (up to 3 years), 1.95% mid-term loans (3-9 years), 2.85% (over 9 years)long-term loans. If you end up forgiving the loan with principal and accrued interest in excess of the gift tax exclusion of $14,000/$28,000 (joint gift) you may be liable for gift taxes.
- Put the Loan in Writing. Drawing up an official loan document will be extra assurance to the IRS that you are loaning money and not just making a gift. This also helps everyone involved in the transaction understand expectations. Sample promissory notes are available online if you don’t want to involve a lawyer. If you are making a loan to family for a home mortgage, make sure the loan/promissory note is written up correctly so your interests are secure. Draw up a mortgage or deed of trust to put the home up as collateral on the loan. Make an amortization schedule that shows the breakdown of principal and interest over the life of the loan.
- Provide assistance in another way. Besides making a loan to a family member, other ways you can help financially are: give a small gift of money or goods (remember the $14,000 gift tax exclusion/$28,000 joint gift), co-sign on a bank loan, create a budget and help them get finances in order, provide employment, help them find financial assistance and local resources.