November 14, 2014 – By Dustin W. Schofield
Lending money to friends and family members is common.
According to a survey by American Consumer Credit Counseling, 82 percent of people would lend money to a family member and 66 percent to a friend. But that doesn’t mean it’s risk-free.
Not only is there a chance you could lose your money, but you may also put your relationship with the borrower in jeopardy.
You can help manage the mixing of your money with the people you love using these four tips:
Ask what the money is for
Instead of automatically responding “Sure!” when your brother-in-law asks for a loan, take a step back and gather some answers.
Ask what the plans are for the funds.
How you respond is likely to differ if it’s to take a class for career advancement versus going on a trip to the Bahamas.
And when it comes to posing questions, don’t let yourself off the hook.
What is your motivation for wanting to get involved?
Only you can decide whether you’re doing it for the right reasons.
Just make sure to dig deep and give it plenty of consideration before saying “Yes.”
Be clear about terms
After you decide to make the loan, it’s time to talk terms.
Don’t be tempted to ignore or pass lightly over this step, even if you would rather avoid the uncomfortable formalities of hashing out specifics.
You will likely save yourself a lot of misunderstandings and conflicts down the line if you work through these questions:
- What is the exact amount?
- Will it be conveyed in one lump sum or installments? If it’s in installments, on what timetable?
- Will you charge interest?
- How will payment be delivered — cash, check, or transfer?
- What is the payback schedule?
- How will you manage late or severely delinquent payments?
Understand the tax implications
If you loan money at a very low interest rate (or without any interest at all), the IRS will assume the amount is a gift, not a loan, and that may carry tax consequences. (In 2014, you can give gifts of up to $14,000 a year per person without triggering gift tax implications.)
The interest you waive may also qualify as a gift.
To avoid these issues, consider charging interest at the applicable federal rate, which the IRS updates monthly and makes available on IRS.gov.
In addition to talking with your financial adviser, make sure to check in with your tax adviser to help ensure you’re clear about how transferring money might affect your tax bill.
Be sure to set reasonable and attainable repayment terms.
If there’s interest involved, an online calculator from a site such as Bankrate (bankrate.com) can help you break down the numbers so you and the borrower can set a manageable repayment schedule.
Also come up with a way to track repayment.
Keeping track of all this information may sound like a lot of work.
But remember that when a loan is handled with care, both parties stand to benefit.