Family Loans: Benefits and Downsides of Borrowing
It could be difficult to obtain a personal, student, or commercial loan if you have bad credit or short credit history. If all other traditional lending avenues have been exhausted, asking a family for a loan can be worthwhile. But you should be aware that family loans can have both advantages and drawbacks.
As long as the creditor and debtor are in agreement on the conditions of repayments and have a signed contract, you can help secure an effective family loan arrangement.
What Exactly Is a Family Loan?
A family loan, also known as an intra-family loan, is one made between members of the same family. Family loans are frequently less official than personal loans through conventional creditors or even in the peer-to-peer (P2P) sector, where potential investors and debtors are connected directly.
Family relations may allow for informal loans, but a loan is also a legal agreement, and loans may have financial repercussions both for the debtor and the creditor. A creditor that collects interest must pay taxes on any interest received from the debtor.
Family Loans: Pros and Cons
Family loans can give you a cheaper opportunity, but they also put your relationship at danger. Consider both the benefits and drawbacks.
Family loans do have dangers, especially for the creditor, however, they can also be advantageous to both parties. A family loan has the following benefits:
- A problem with poor credit might not even arise – Family loans have different lending requirements than other loans, which is a significant difference. Household members don’t typically consider your credit history when granting you a loan. Despite your credit problems, a household member will probably be more understanding if you have bad credit.
- An intention to be kind – It can be satisfying to support a loved one during difficult times, especially for the creditor. The member of the household can feel proud of themselves for supporting the family financially.
- Lower interest rates are possible – Household members often have lower interest rates than conventional creditors. This may result in cost savings for the debtor during the life of the loan. It is up to the lending relative to select a lesser interest rate.
- Decreased risk of financing fraud – If your relative needs funds badly and has bad credit, they might be more prepared to take on more risk to obtain a loan. They will take on less risk if household members borrow from you and have a workable plan in order for paying you back.
- The creditor may receive interest – A relative who collects interest will be compensated for their services.
- Greater repayment flexibility – There is more latitude in the repayment schedule because the debtor isn’t receiving funds from a bank. If the payback is not made on time, a household member might be a little more understanding.
Family loans can also come with a lot of dangers. The following are some issues that both debtors and creditors may run into:
- Household dynamics – If the loan is not repaid in accordance with the agreed-upon terms, borrowing funds from and even lending funds to a relative may cause trouble. A creditor should think about the repercussions of not getting their funds back before lending to a family.
- Your credit score won’t increase as a result of this – Even though the debtor repays the loan in full and on time, this positive history won’t be disclosed to credit bureaus since family loans are just a private affair. A family loan is indeed a missed chance to establish good credit.
- Recovering from losses can be challenging – When a household member defaults, creditors might not be successful in getting their funds back. If the creditor wishes to call in the past-due debt, it will be challenging to enforce the informal arrangement because of this. Courts and the IRS frequently perceive it as a present instead of a loan.
Should You Borrow Family Loans?
Family loans might carry a high level of risk. Consider establishing these terms before any funds is exchanged:
- Loan conditions – Before making a loan, the debtor and the creditor should preferably agree on a payment plan and an interest rate. A written agreement should specify the loan’s terms.
- Legal action – The creditor must either choose to sue a relative or bear the loss if the debtor fails on the loan. Lending funds might not be a good idea if you can’t afford to lose it.
- Limitations on use – For instance, in some circumstances, down payment funds from unsecured loans, such as family loans, aren’t regarded as acceptable funding sources for a loan down payment. Therefore, you should consider twice before taking out a family loan for a down payment on a house.
Alternatives to Family Loans
Relationship dynamics may get complex if funds and family are involved. If you don’t feel a family loan is the best option for you, here are some other alternatives to look into.
Send a gift
If you have the resources, you might want to think about sending funds to members of the family without any conditions. For 2019, members of the family are exempt from gift tax laws if they contribute up to $15,000 to each individual giftee.
Apply for a personal loan
You may also have a better chance of obtaining a personal loan if a member of the household is unable to lend to you. A household member might agree to co-sign a loan in particular circumstances. If a member of the household co-signs the loan, they consent to take on the debtor’s debt in the event of default.
Keep in mind that if the debtor is late with payments, both the debtor’s and the co-credit signer’s are at risk.
A company loan is an option
When launching a firm, entrepreneurs have a range of loan options to explore. Company credit cards, SBA-guaranteed microloans (usually under $50,000), loans from banks or community development organizations, as well as conventional business loans from banks or peer-to-peer creditors, are some of the popular funding options for small-business owners.