Lack of documentation. Many times, when we loan money to friends or family, we don’t bother to document it in writing. This makes it very easy for miscommunication to arise regarding the terms agreed to verbally. You can minimize this though by easily documenting the personal loan.
No collateral. From the lender’s perspective, collateral can make or break the deal as it gives them greater surety and trust in the borrower. But, if that collateral is not documented in writing, the lender may never receive it even if the loan defaults. To prevent this from happening, refer back to point 3. Learn more about collateral for secured loans.
The loan may be taxable. Unless fully documented with payback terms including an interest rate and proof of repayment, loans over $15,000 may actually be taxable under Federal law. To avoid the potential for a gift tax assessment, always document non-bank personal loans so that there are no surprises at tax time! Learn more about IRS gift tax rules.
Awkwardness. For lenders, having to constantly remind the borrower or demand payment can be an uncomfortable affair. Read on…
Destroyed relationships. Anytime you loan money to somebody else, you run the risk of not receiving some or even any of your money back. This can result in a loss of trust with the borrower and, in some cases, the end of that relationship. If you are going to loan money, think through the consequences of not getting paid back. What will you do if you never see a dime?
Increased debt. For some borrowers, the loan only serves to pile on additional debt that they really don’t need and can’t afford. Goodhearted lenders should always assess if they are truly doing the borrower a favor.
Bad habits nurtured. People who borrow but never pay back will likely continue to ask for more cash continuing the cycle of bad behavior – until people finally stop loaning them money! For parents, this can be especially troubling as they begin to teach their children good fiscal habits and the virtue of fulfilling obligations. Here are some ways parents can instill good monetary habits in their children through small personal loans.
Not all is lost. While there are some potential drawbacks to loans between friends and family, there are some distinct advantages of friends and family loans that make them the perfect fit for many borrowers.
