(From “6 tips on borrowing from relatives” by Jennie L. Phipps)
When people find themselves in a money crunch, a natural reaction is to turn to family for help. Parents, grandparents and siblings often are happy to lend a financial hand via a loan. But unless handled carefully, family members — not just the relative advancing the cash, but others — will be resentful.
“There’s no such thing as a family loan without emotional ties,” warns Azriela Jaffe, entrepreneur and author. “If you don’t understand that from the beginning, it will take you by surprise.”
Jaffe says borrowing money from parents, the most-common scenario, can put you back in the same place you were when living under their roof. “Mom and Dad are paying the bills and they feel entitled to tell you what to do. All of a sudden you are 13 again and rebelling.”
Faced with the need to rely on some all-in-the-family money, how do you minimize the potential for resentment and destructive situations? Here’s some advice from people who have been there:
Know from whom you borrow
Houston bankruptcy lawyer John Ventura says before you seek a loan, analyze your relationship with the lender. Ask yourself, “If I lose the money, what will be the outcome?” Relatives for whom money is an obvious emotional issue or those who really can’t afford to lose anything are not good lending candidates, he says. Moreover, you put people in a tough spot when they have to turn you down, creating hurt feelings all around. When you ask, be prepared to handle a refusal graciously.
Seek a co-signer
If the bank will accept a parent or relative’s signature on the note as a guarantee, go that route. Tom Gillis, Houston lawyer and CPA, put up bonds as collateral and signed his son’s notes twice when the younger man opened a heavy equipment manufacturing business. “It’s much more businesslike,” says Gillis. “The bank drew up all papers. All I had to do was sign my name.” The good news is that eight years after the first loan was made, Gillis’ son brought over a bottle of champagne and the paid-off notes.
Put everything in writing
It may be sufficient in a very simple transaction to write a letter that specifies the terms of the agreement. But the best way may be to get a lawyer involved, particularly if it is a significant sum of money. That protects both sides. “Give your family the same respect that you’d give a professional lender,” says Jaffe, author of the Complete Idiot’s Guide to Beating Debt. “In return, that increases the chances they’ll treat you with respect.”
Know the tax laws
If the loan is for less than $10,000, it will probably escape the IRS’ attention. But if your family loan is for a significant amount, make sure you understand the tax and other legal consequences, particularly if the lender dies before the loan is paid off. The IRS considers loans that are forgiven as taxable income. James Walsh, an insurance consultant and author of Family Money, suggests insuring the lender’s life for the amount of the loan as one way to guarantee repayment and avoid tax problems.
Give lenders something tangible
Specific collateral for either co-signers or lenders will ease concerns and ensure that they don’t lose everything if things don’t go well. Bankruptcy attorney Ventura says that if you are forced to file bankruptcy, provided you’ve structured the agreement properly, your lender will have a lien on your house or your car. That will put them at the top of the list of creditors. “You and your relative will get peace of mind. And if you have a close enough relationship and the item is repossessed, chances are it will just be given back to you,” Ventura says.
Tell the world your business
You may think the financial deal is just between you and dad, but family secrets are hard to keep. Siblings, in particular, are likely to be concerned about loans from parents. Gerald LeVan, managing director of LeVan Co., family business consultants based in North Carolina, recommends telling other close relatives how much you’re borrowing, why you’re doing it and then keeping them posted about how your financial affairs are going. “It cuts down on the feelings of favoritism and jealousy,” he says.