Need to raise funds in a pinch? One tried-and-true solution: Borrowing money from family or friends. But a family loan can incite a family feud if expectations aren’t set out clearly—and subsequently met.
While a small short-term loan can be arranged with a hug or a handshake, larger loans should have a more formal structure. These tips can ensure that when you borrow money, neither the funds nor the relationship disappears.
Have a Plan
Whether you’re borrowing money to repair a car, put a down payment on a house, start a business, or pay off the plane ticket you bought to visit your ailing grandmother, approach the loan as a business deal. Explain to the prospective lender why you need the money, why your planned use of it makes sound financial sense, and how you intend to pay it back. Be realistic about what a practical repayment plan would be, so that both you and the lender know what to expect. For example, if you want to borrow $2,000 but can pay back only $100 a month, make sure you both understand that it will take nearly two years to settle the loan.
Put It In Writing
Even if you’re borrowing money from someone close to you, a written loan agreement can make both parties more comfortable with the whole arrangement—especially if you’re borrowing a significant amount. A formal contract shows that you respect the lender and understand that repayment is required. Furthermore, if you should die, the lender will have proof to get the money back from your estate.
You can create your own promissory note—legalese for an IOU—or buy one online; Nolo.com provides a form that covers all the bases for $34.99. Whether you choose a do-it-yourself contract or a formal promissory note, make sure to include:
- Names and addresses of the lender and borrower
- Date of the loan initiation
- Amount of the loan
- Payments schedule (weekly, biweekly, monthly)
- Minimum payment amount
- Date by which the loan is to be repaid.
Consider Paying Interest
If you are asking your dad to tap his savings to lend you money, it’s only fair that you should offer to make the interest he’s losing for the duration of the loan. Furthermore, charging interest might help the lender avoid a tax hit. That’s because if the loan amount is more than $14,000, then the lender could be subject to the IRS gift tax—unless the lender charges a minimum interest rate set by the IRS. The IRS publishes an index of Applicable Federal Rates monthly. The annual rate for a short-term loan (defined by the IRS as three to five years) is currently 0.42 percent, which translates to $4.21 a year for every $1,000 borrowed.
Build a Good Credit History
When you’re borrowing money, demonstrate that you’re a good credit risk by paying on time—every time. Make sure there is an ongoing paper trail showing proof of repayment and plenty of receipts.
Shakespeare wrote that loaning money to a friend is a good way to lose both the friend and the money. But once you’ve established a solid track record, you’ll be able maintain the funds and the friendship.
This article originally appeared in Consumer Reports.
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