Posted By: CFP&WM On: Feb 22nd, 2010 In: In the news

Senior Spectrum September 8, 2009

Avoid Problems When Lending Money to Family

It can happen at any time. Your child or grandchild describes to you a financial predicament they are in and then asks you for a loan. The reasons can be varied — the purchase of a home, schooling costs, job layoff, health problems or to decrease credit card debt.

Regardless of the reason, you need to avoid some common problems when this happens to you. To start with, you need to be in a financial position to make the loan. Remember, you need enough liquid assets for your own financial safety net.

How would you be impacted if the loan was not repaid? After looking at your own circumstance, it might be best to not offer the loan and say, “I would really like to be able to help with your current money troubles, but after looking at my own finances, I do not have any extra money to lend you.”

Many younger people do not have a good handle on their finances and are over-extended because of making poor buying decisions. If they’re asking for the money to buy a new car when they have a perfectly good older car, or they want to go on vacation, you may be doing them a favor by NOT making the loan.

If you do consider making the loan, be sure to understand their total financial situation (just like a bank or some other lender would do). Your loved one may not want you to judge them, so they may not be telling you their whole financial story. Ask to see a copy of their current credit report to determine that they are not totally underwater and that you have the whole story. (They can get a credit report for free on the Internet at www.annualcreditreport.com)

If you can afford to make the loan, it’s for a legitimate reason, and they are technically solvent, the next step would be to agree on the terms of the loan. What is the amount to be loaned? On what date? What is the term of the loan? What is the interest rate to be charged? What is the date each month the payment is due? What is the date when the payment is late? What are the penalties for late payment? And is the loan callable or not?

If the family member requesting the loan is married, are you in fact making the loan to both of them or just your family member? This could be important in case of a divorce.

If you have a living trust, the promissory note should reflect that your trust is making the loan and not you personally.

Put the terms of the loan in writing. You can go on the Internet and Google “promissory note,” where you will have several contracts from which to choose. The best option would be to talk to your attorney and have the note professionally prepared.

Should you make a loan to one family member, do you want the rest of the family to be aware of this loan? Full disclosure is many times best, but the loan could be an embarrassment to the borrower. Disclosure might lead to requests for loans from other family members. Would you be in a position to help them as well?

Keep in mind that the loan must have a declared interest rate, according to the IRS. If a loan does not have a stated interest rate, the government will determine the rate for you, which could impact the income taxes of the borrower or for you. Talk to your tax professional to be sure that you are aware of the implications of an interfamily loan.

If you want to keep the loan on a more professional level, you can use the services of a company such as Virgin Money US. For a one-time fee of $199 and a monthly fee of $9, this company will prepare the documents, collect the money each month and deposit it into your account.

To restate, if you get asked to make a loan, do not say yes until you’re sure that you are in a position to make the loan, you know what it is for, you know the borrower’s financial situation, and you both agree on the terms, then reduce it to writing, know your tax implications and its impact on your estate plan.

Michael Chamberlain is a Calif. Registered Investment Advisor. Send your questions to him at mike@chamberlainfp.com or call (800) 347-1340.

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