It is not uncommon for friends and the immediate family members to ask for money from you or another close member of the family. This is an eventuality you will have to confront or deal with at some point in time or another. That is why it pays to know more about the subject matter.
Definition of a Family Loan Agreement
A family loan agreement is not so different from your ordinary loans. It is that arrangement that facilitates or oversees the advancement of some amount of money from one member of the family to another one. Though unregulated, this, in fact, the most common form of debt financing for start-ups.
Owing to the risks involved in any debt financing, the entire process must be overseen by a duly signed and executed agreement. That will also aid with litigation and reduce to a considerable extent any risks that might often arise.
Things Should be considered before lending money to family members
Alternative Options: Lending money even to a close relative is generally quite risky. It is the last thing you want to do. That is why you must ask yourself if there be any other options than lending that may be similarly viable before lending out.
The Amounts Involved: How much money is the relative asking for? There is a direct correlation between the amounts involved and the risk factor that comes along. Put differently: a higher amount will often come along with greater risks and vice versa.
Repayment Plan: It is one thing to borrow and yet another one to repay. As part of your assessments, you want to know how long the debt will take to be repaid. You want to go further down to know the breakdown of the repayment.
Grace Period: This is the time interval between when an amount is lent out and when the first repayment installation is remitted. Though there is no fixed grace period, higher amounts are often subject to longer grace periods and vice versa.
The creditworthiness of the Lender: You also want to find out the creditworthiness of the lender in question. How likely is it that the person asking for that money will repay it within the stipulated deadline? Factors like financial resource endowment, age, health/medical history, and occupation are key determinants of this.
Interest Rates on a Family Loan
A family loan is privately negotiated and is hence not governed by the prevailing state and federal regulations. Nonetheless, many financial experts and institutions recommend 0.68% for “short-term” loans with a repayment period of no more than three years.
They further recommend 1.33% for the “mid-term” loans with a maturity of 3-9 years, and a further 2.07% for “long-term” loans whose maturity stretches beyond nine years.
Basic Terms of a Family Loan Agreement
Repayment Methods: This refers to the options that the person borrowing shall take to refund the money owed. There are two kinds of methods, namely the on-demand and the fixed repayments, respectively. The former gives the lender the leeway to ask back his money at any time. With the latter, the borrower returns the money at a specified date.
Terms of References: All loan agreements have to be handled subject to certain terms and conditions. These define the scope and obligation of each party involved in the process. Some of the issues it dares to set straight are the jurisdiction of contract, defaults, breach of contract and any penalties applicable.
Arbitration and Litigation: If and when issues go south, they have to be deliberated and handled appropriately. That is where arbitration and litigation come in. These are mechanisms that are put in place to handle any emergent issues and settle them appropriately.
Interests and Collateral: A family loan for a large part, does not require any collateral. However, under exceptional circumstances, the lender may demand the same. If and when this applies, the agreement has to stipulate that. As part of the agreement, you have to state the interests that shall apply clearly. On the same note, you have to delineate the collateral that has to be given in exchange for the loan.
Penalties: Though not a prominent aspect of the family loans, the penalties may apply from time to time especially in case there is some negligence on the part of the borrower. You have to similarly state the penalties applicable and the circumstances under which they apply.
Family Loan Agreement Examples
Sample Family Loan Agreement Template
Family Loan Agreement
Promise to Pay
For value received, _______________________, (the ‘Borrower’) promises to pay __________________________ (the ‘Lender’) $__________ and interest at the yearly rate of ______% on the unpaid balance as specified below.
Borrower will pay ____ monthly installments of $_______ each.
Date of Installment Payments.
The borrower will make an installment payment on the ____the day of each month beginning ____________, 20___ until the principal and interest have been paid in full.
Application of Payments.
Payments shall commence with interests first followed by the principal
The borrower may prepay whole or part of the principal penalty-free
If a borrower falls behind loan repayments by more than ____ days, Lender may declare the entire outstanding balance due immediately, together with the accrued interests.
(Given that this is a family loan, there is no collateral.)
– – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – –
This family loan agreement was signed and dated on the ____ day of _______________, 20_____
(Both parties sign and receive copies of the original)
Tax Implementation on family loan.
The Internal Revenue Service is only mandated to levy taxes on loans rather than gifts. It hence has to find out whether the amount of money advanced is indeed a loan. At present, the minimum rate of interest stands at 0.38% for loans whose maturity periods are below three years and 1.85% for loans that mature between 3 to 9 years.
To implement the requirements, the lender has to file the IRS form 1098 that showcases the prevailing rate of interest that the borrower remitted over each year. The borrower has to demonstrate these in his tax returns.
Frequently Asked Questions (FAQs)
Should you lend money to your family?
A. WHY NOT? Most start-ups have been established in a like form or manner. This form of financing is, in fact, superior to the commercial banks in that it obtains faster approvals and is governed by less stringent rules and regulations. Only be cautious about lending what you can do without.
How much money can you loan a family member?
There is no fixed amount of money you can or should lend to a family member. The exact amounts all depend on your financial power and the creditworthiness of the family member who is borrowing the money. It is strongly advised that you lend no more than $14,000 to a family member at a time.
Can I loan money to a friend?
YES, you can! The same rules, considerations, and regulations as that of the family loan agreements apply. You want to take extra precautions though not to lose the friendship as this possibility is usually rife with such borrowings.
Which day should we not give money to others?
A. Many people contend that Thursday is not the best day-to-day to advance loan to another person. The reasons behind this are unclear and lack credible statistical backing. So, go ahead and lend at a time when it is convenient for you.
Can I give my son money to buy a house?
Why should you not? Rather than give your child the gift free of charge, you want to teach him some financial due diligence and responsibility. That can only happen if you advance him the loan and ask to repay later with interest.
There you have them! Have you not found the inspiration you badly want when it comes to family loan agreements? The pieces of information we have furnished above should get you started well. Still not sure how to set out? You may always speak to us for further inspiration!