Most people experience financial hardship at some point in their lives, which may lead them to think about taking out a family loan to get them through. These often occur when the person encounters unforeseen circumstances like losing their job, incurring unexpected medical expenses, or having their automobile break down.
Knowing the advantages and disadvantages of borrowing money from family is crucial if you consider applying for a family loan. Continue reading to gain the details you require.
What is a family loan?
Any financial loan from one family member to another is considered a family loan. Traditional lending institutions like credit unions and banks are not involved in family loans. A family loan, or intra-family loan, is made between family members. Family loans are frequently less formal than personal loans from conventional lenders or in the peer-to-peer (P2P) sector, where potential investors and borrowers are connected directly. On the other hand, family loans could have no contracts or only straightforward agreements where the borrower or lender keeps track of the interest due and payback schedules.
Advantages of Borrowing Money from Family
Below are the advantages of borrowing money from family:
1. Flexible Options
One of the main benefits of borrowing money from family members is that you may work out more flexible payment and payback terms.
2. Lower Interest Rates or Interest-Free Rates
Your family member may not charge interest on the loan they give you money for, or they may be willing to accept a lower and more reasonable rate than what a bank would charge.
3. Rough credit is not an issue.
Nothing prevents family members from lending to one another, even if the borrower has a bad credit history.
4. A Longer Repayment Period
There’s a strong probability that your family member will be more flexible regarding the loan repayment duration, as they might be more understanding about the interest they add to your loan than a financial institution or payday lender.
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Disadvantages of Borrowing Money from Family
If you’re thinking about taking out a family loan, make sure you’ve thought about all the possible drawbacks, which could include:
1. Lack of Clarity
Family loans don’t require documentation typically connected with loans from banks and other institutions because of their informal character. This may result in misunderstanding the conditions and misplaced expectations between the parties.
Many people who lend money to friends or relatives do so based on faith that the borrower would repay them in full and on time. However, it would be in the best interests of both parties to establish a contract outlining the specifics of the loan. The loan amount should be specified in this agreement.
- The amount of money being borrowed.
- The timetable and payback terms (for example, payment frequency, payment amounts, and a final payoff date).
- The loan’s interest rate will be assessed.
- What happens if the borrower stops paying back the loan?
2. Social Awkwardness
Someone who lends money to a family member wants to avoid reminding them of the loan or inquiring when they should expect the next return. Keep the lines of communication open with anyone you’ve borrowed money from, especially if they are a family member.
Making them feel uncomfortable about broaching the matter with you is unfair. If you ignore them or shift the subject, it could make them feel resentful and angry.
3. Damaged Relationships
Everyone who agrees to give a family member a loan is only sometimes content with it. Some individuals could feel obligated or compelled to carry it out. Others might decide to provide the money but, by doing so, place themselves in a risky situation. These conditions don’t bode well for either partner and may cause previously happy relationships to fall apart.
4. Tax Implications
Sometimes, a family loan may cause tax problems for the lender, adding unneeded stress and further administrative and financial strain. Lenders are permitted to charge a fair interest rate but must also pay taxes on the money they receive from the loan.
The IRS can also classify the lender’s loan as a gift if they charge less than market interest rates. The lender might be required to pay gift taxes if this occurs.
Alternatives to Family Loans
Relationship dynamics may get complicated if money and family are involved. If you think there are better options than a family loan, here are a few alternatives to consider.
- Give a gift
If you have the resources, you can send money to family members without any conditions. For 2019, family members are exempt from gift tax laws if they contribute up to $15,000 to each giftee.
- Use a personal loan.
You may have a better chance of obtaining a personal loan if a family member cannot lend. A family member might agree to co-sign the loan in particular circumstances. When a family member co-signs the loan, they consent to take on the borrower’s debt in the event of default.
Remember that if the borrower is late with payments, both the borrower and the co-credit signers are at risk.
- Consider a business loan.
Borrowing from friends and relatives may not make sense if you’re trying to launch a new business or turn aside a gig into a full-time job. When launching a firm, entrepreneurs have various loan options to explore. Small-company owners frequently use business credit cards, microloans, SBA-guaranteed loans from banks or community development organizations, or conventional business loans from banks or peer-to-peer lenders as sources of capital.
- Make a family member an authorized user.
Not willing to donate money to a relative or co-sign a loan? By including them as authorized users on your credit card, you can still assist them in improving their credit scores.
The bank may add information about the primary credit card holder to the authorized user’s credit reports when a credit card holder adds someone as an authorized user. The new authorized user’s credit ratings might increase if the principal cardholder has a strong credit history. A lender may grant a loan to the authorized user if they have a better credit score.
- Access On-Demand Pay with Earned Wage Access
Earned Wage Access is a substitute for taking out loans completely (EWA). EWA platforms provide a valuable substitute for high-cost credit products like overdrafts or payday loans by enabling you to access some or all your earned wages before your next scheduled paycheck. There are various ways to get access to your earned wages. The money can be sent to your bank account, placed into a debit or prepaid card, or even picked up in cash at Walmart.
Alternatively, you can pay your bills in full within the app and use your earned money to pay for services like Uber and Amazon. Also, ask your company about Payactiv’s Earned Wage Access services and financial health solutions if you are in a challenging financial situation.
Ideally, the lender and the borrower benefit from family loans. However, if the family loan fails, your relationships and credit scores may be damaged.
Consider all of your options before lending to or borrowing from family members. If both parties still agree that the family loan makes sense, ensure everyone is on the same page by putting the loan in writing and keeping close track of the repayments.