Family Matters: Rules For Loans To Family Members

If you have ever found yourself in a tight spot financially and in need of a quick fix, you may have considered turning to members of your family or even your closest acquaintances to arrange a loan. In fact, recent research by Royal Bank has indicated that 78% of Canadians have lent or borrowed over $500 to a family member, with the average value of such loans approximated at $6000.

living arrangements and housing are often reasons to negotiate loans to family members

However, engaging in lending or borrowing with family can be a tense process. Relationships can be stressed by the introduction of monetary pressures – it can be awkward, emotionally sensitive, and difficult to approach someone you know well in search of a loan. More importantly, the relatively few rules and regulations on this type of lending make it difficult to secure your money whether you are the lender or the borrower.

Still, if both parties are comfortable with the situation and the request stays conflict-free, setting up loans to family members can be a way to save money, especially in the case of taxation and income splitting. There are some important rules to follow, however.

Communicate Your Goals and Needs

Both the borrowing party and the lending party in the case of a loan between family members should spend the time needed to talk about what they expect. Don’t assume that anything is obvious to anyone. Understand the purpose of the loan and the expectations for repayment. Even better, get it in writing. Be upfront with your plans and have all family members involved in the financial exchange sign off on the plan.

Minimize Your Risk

Family loans should be a win-win arrangement between borrower and lender. With any loan the lender is taking risk, but you should try to minimize that risk. Some family members may not have sufficient assets to lend money. They may be tempted to put their financial future at risk, and that’s probably a bad idea. Lenders should be hesitant about family loans that require them to tap into retirement funds, emergency savings or home equity. Much in the same way that you would avoid the risks of a payday loan or other commercial financial product that might appear “too good to be true,” don’t let emotional attachment or impulse prevent you from realistically and objectively considering a loan to family members as a viable financial option. Always check with a tax advisor or financial professional to make sure that lending to family or splitting income will be advantageous and sustainable for all parties involved.

Get it in Writing

I mentioned this already, but it’s too important to overstate: make an agreement and formalize it rather than going ahead on the bond of personal familiarity between you and your lender/borrower. This should not be meant as a display of distrust to your family members: it’s simply done in recognition of the fact that sometimes, things come out of the blue to affect our financial obligations, and it’s best to be prepared. Start with repayment planning. When determining a repayment plan consider the amount and the schedule – does weekly, biweekly or monthly make the most sense to each of you? Decide when payments start and how payments will be made.

Once you’ve set out a plan, keep track. Record every payment, and make note of any change in payment plans. Make sure you provide or receive receipts for the payments. And, if interest is going to be paid and or received, don’t forget to report it to the Canada Revenue Agency.

Loaning money to family members can potentially be financially advantageous, but the process requires a great deal of careful consideration before your money changes hands.

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