An In-Depth Overview of Family Loans
Lending within the family members is an appreciating idea to consider. It’s easier to get approval, and the interest remains in the family only rather than going to some third party.
Family loans tend to be successful in most situations, but they require open conversation and planning beforehand. Moreover, there is also the requirement to handle administrative matters and the emotional side of things.
While you are opting for other loans such as Commercial Real Estate Loans, then there are no such emotional sides to cater to.
In this blog, we will shed light on family loans and other related factors.
What exactly is a family loan, and how does it work?
- A family loan is also referred to as an inter-family loan that exists between family members. One family member tends to give a loan to the other person who needs financial assistance. The purpose does not matter much. It is just a loan in which there is no involvement of a bank, a credit union, or other traditional lenders outside the family.
- A family loan is quite different from a gift or present, which is defined by the IRS as the transfer of money or property to other people without any expectation to get something in return. The fact is that you have to apply market interest rates to the lending or borrowing amount, which is treated as a loan.
- In case you are offering a loan at lesser interest rates as compared to the market interest rates, then it will be considered a loan. The loan is advantageous for both, be it a lender or a borrower. Lenders are expected to comprehend the alternatives, tax implications, risks of a family loan.
What are the alternatives to family loans?
This is indeed a good idea to aid someone financially you care for without expecting anything in return. But you can also consider two major ways to help your relatives other than lending money to them.
- Gifting: If you are giving something to a family without having an expectation in return, then that is considered a gift. It is going to put an extra financial strain on the relationship.
- Co-signing: You can also have the option of co-signing that your family members take out to help them get approved. The income and credit might be adequate to assist them in approving the loan. In co-signing, you will take the responsibility that your relative will repay the debt on time and in full.
Benefits to consider of family loans:
A family loan is going to offer many benefits to the borrower or lender. However, there is a factor of risk in this arrangement.
- Lesser interest rates: The substantial benefit of these loans is that the borrower will get the loan at a reduced interest rate than a traditional loan.
- Loan terms with mutual decisions: The good point is that you can decide on loan terms with mutual agreement. This is a feasible option that you cannot get in a traditional bank.
- Forbearance: Forbearance is an additional factor that is the feature of a family loan. It means there is a pause or reduction of a loan amount for some time if there is an emergency.
Such factors of emergency are not considered in a traditional loan form.
The drawbacks of family loans:
- Risk of non-payment: There is always a risk of non-payment in the family loans. You might be assured that your relative will pay the loans, but you may never know when a person falls into the trap of harder times and fails to repay you.
The traditional lender may opt for some stringent actions to get the loans to amount back, but you cannot resort to such actions. Moreover, while giving a loan, there is no such preparation or strategies to safeguard the risk of default.
- Ruined relationships: In case the borrower is not able to pay back the amount loan, then it would lead to ruin the relationship forever.
- No availability of funds: The money which you deposit in the bank can be availed of at any time when you need it. However, this is not the case with family loans if you have invested in a family relationship.
Pre-requisite before offering family loans:
Before you set off with the family loans, you need to consider a few factors. Both lender and borrower need to be involved in the discussion.
A lender must make sure that he knows the basics of family loans and other factors which play a crucial role.
Have a word with a local attorney:
Make sure you engage the services of an attorney to get to know the risks and any option to save yourself from any substantial risks.
- Motivate the borrower to deposit the funds safely
To mitigate the risk factors, you should try to encourage the borrower to keep the funds in an FDIC-insured bank, or it should be secured with the credit union.
- keep it in writing : You must use a written loan agreement to be sure of the amount of return you are offering as a loan. A written agreement will keep the contract safe, and you would not need to walk empty-handed. You can use the template documents which can be provided by local attorneys.
- Try using collateral: For a safe lending option and to ensure you get your money back, try using collateral. It means that you acquire an asset of value and sell it to recover your money if the worst-case scenario arises.
- Comprehend tax laws: While you lend a loan, make sure you have a basic understanding of tax laws. Have a word with a local tax advisor before you sign an agreement. Learning some essential basics of loans will give you a clear picture of loans.
The bottom line:
Overall, getting involved in family loans requires you to take into consideration many factors. You need to apply extra caution, especially if you are a lender.
If you want to get information about other types of loans such as Bridge Loans For Real State or Real Estate Finance Services in the USA then get in touch with VP Capital which has a forte in real estate loans and can guide you well in this regard.