A loan to a relative can actually be a sweet deal for both sides, if
it's served up correctly.
By Linda Stern, Money Magazine
September 14, 2009: 01:10 PM
(Money Magazine) -- When Brian Hetherington complained to his father
two years ago about the weighty 9% rate he and his wife were paying on
their home-equity line of credit, Jim, the senior Hetherington, had an
idea. He could lend the couple the $100,000 to pay off the loan and
charge them only 6%. It's been win-win ever since. "We haven't missed
a payment," says Brian, 43. And his folks are still earning a return
on their money.
With banks stingier in the credit they're offering to borrowers,
families are finding that it pays to cut traditional financial
institutions out of the equation. While the bulk of interpersonal
lending is informal and hard to track, there's clearly a lot of money
moving around. At Virgin Money, an online company that facilitates
such loans, volume has more than doubled in two years, to $425 million.
Perhaps you're considering helping an adult child buy a first home,
aiding a sibling who is struggling with debt, or supporting a relative
who's lost a job. Those are laudable objectives, but beware before
putting up serious money.
"Lending to family can be dangerous," says Dennis Stearns, a
Greensboro, N.C., financial planner who has seen deadbeat relatives
and bad communication doom deals and damage relationships.
In fact, according to a recent Money survey, 43% of readers who lent
to family or friends weren't paid back in full; 27% hadn't received a
dime. To avoid joining this unfortunate club, follow these steps
before offering an advance.
Check your reserves. The arrangement can go wrong on either end. On
your side, you want to be sure of two things. First, that if the loan
falls through, it won't destroy a cherished relationship. And that you
can truly afford to give up the money being requested.
The emotional part is for you alone to judge; we'll stick to the
practical side of the equation. To start, verify that the loan won't
jeopardize your retirement. Use T. Rowe Price's retirement income
calculator to see if you'd be able to manage comfortably if the money
isn't repaid. You also shouldn't play banker if it means taking on
debt or selling assets you're not prepared to sell -- especially if
the latter would trigger capital gains taxes.
Even if you can swing the loan, be sure your immediate family is
onboard. Troubles can arise if you want to make the deal and your
spouse doesn't. If you're lending to your child, bring his or her
siblings into the loop; a big loan to one could reduce funds available
to the others or be seen as favoritism.
Vet the borrower. On the other side, you must consider the likelihood
that the borrower will pay you back. You probably already have a sense
of whether he or she is a good risk, based on past behavior. But go a
step further. Request that the person produce a credit score and
report so you can see how she has managed other loans (look for late
payments and delinquencies).
"And ask for a debt-repayment plan," says Burt Hutchinson, a Lewes,
Del., financial planner. This will help you see if the borrower is
willing to take this arrangement seriously. Also, if it's a loan for a
business, make sure you get a copy of the business plan.
Definitely don't lend out of guilt. If the person appears to be a bad
risk, "just say, my financial adviser is telling me I can't afford to
do this," says Hutchinson. Lessen the sting with an offer of
nonfinancial help -- such as babysitting -- so the would-be borrower
can work longer hours.
Set your terms. Families often low-ball the interest rate on personal
loans, but if you go too low, you can run afoul of Internal Revenue
Service rules -- of which there are many. For starters, you're
supposed to declare and pay tax on the interest earned. If the loan is
over $10,000, you owe tax on at least a minimum rate, even if you
don't collect. The IRS posts what it calls the applicable federal
rates on its website.
In September the rates were 0.84% for a loan of less than three years;
2.87% for three to nine years; and 4.38% for any loan over nine years.
If you don't declare the interest on your taxes, the loan could be
considered a ploy to avoid gift or estate taxes, and that's a whole
other headache, says Michael Yuen, a Rockville, Md., CPA and financial
planner.
Set the repayment schedule with the borrower, and finally, make it
clear what rights you have as lender. If you're bailing out a debt-
ridden child, for example, you may want to stipulate how she spends
her money until you're paid back.
Write it up. It pays to have a paper trail, for both IRS purposes and
your own. Putting the agreement in writing emphasizes that this is a
business arrangement.
You can opt to have a third party administer the loan for you. Or
download a fill-in-the-blanks promissory note. Include the amount
borrowed, the interest rate, and the repayment schedule. Sign it in
front of witnesses. And seal with a kiss if you'd like.
--------
Sent from my iPhone.
Posts
No comments:
Post a Comment