Lending money to loved ones
Ellen McGowan considers herself a generous person
and a good mom, but that combination sometimes gets her into trouble.
The Toronto-area mother estimates she's lent her 30-year-old son
between $10,000 and $15,000 in recent years and hasn't seen a penny
"It's a thousand here and a few thousand there,
but it adds up," says McGowan, who asked that her real name
not be used. She admits she has never formalized the loans, relying
on her son's word that she'd be repaid. She has even gone into debt
by using a line of credit to bail him out.
"He's my son -- it's hard to say, no
and I want to help him," she says.
It's a common refrain among people
who lend money to loved ones. While many experts advise against it, people do
it all the time to help family members cope with a job loss, start a business,
pay for education, buy a house or car or, as in McGowan's case, cover debt.
not a big stretch to see why borrowing money from family and friends can destroy
a relationship," says Oliver Harris, a financial consultant with Investors
Group in Orangeville, Ontario.
it doesn't have to be that way. By taking precautions before agreeing to a loan
between loved ones, you can avoid a sour loan and family drama.
paper trail is important
"If people come to
me first, I can help them; if they come to me second, I become very rich,"
says Toronto lawyer Howard S. Dyment, referring to the expensive legal battle
that can ensue when a lender tries to get a lax borrower to pay up.
it may not make financial sense to pay a lawyer $600 to $1,000 to draw up the
terms for a loan of less than $10,000, such lenders still need protection. So,
make the exchange official with a promissory note outlining terms, such as the
amount, interest, a payment schedule and a plan of action should the borrower
Make sure both parties sign
the document, and keep a paper trail that includes payment details and receipts.
with the most common type of loan -- parents helping a married child buy a house
-- it pays to be shrewd. When parents simply hand over $100,000, it's a gift to
the couple. That's fine if the duo lives a long, happy life together, but what
if the marriage falls apart? Do the lenders want their cheating ex-son-in-law
to walk away with their $50,000 when assets are divided?
To avoid such a scenario, Dyment
advises having a lawyer draft the proper paperwork to draw a $100,000
second mortgage with a reasonable interest rate. The parents may
not intend for the couple to pay back the money, but the documents
are in place to ensure that if there's a divorce and the house is
sold, the $100,000 plus the interest goes back to the parents.
Another key step is redoing the
parents' will so if they die, the loan will be forgiven. Otherwise,
the couple may have to sell their home to settle the estate.
At first, the idea of charging interest
on a family loan may cause lenders and borrowers to balk, but there are advantages
in doing so.
For lenders, charging
a nominal amount of interest, even if it's less than the banks'
current rate, is a chance to offset some of the loss they'll incur by lending
the money instead of investing it.
It's also a precautionary measure,
says John R. Mott, a Toronto-based chartered accountant. "If
there's a risk that the loan might go bad, you'd want to have an
interest rate on it," he says.
borrower defaults, the lender can claim a capital loss with the Canada
Revenue Agency, but only if it appears the loan was made to earn income. If
no interest is charged, the claim isn't allowed, nor is it granted on loans between
close family members, such as parents and children or between siblings. It does,
however, apply to loans made to extended family or friends.
in mind, warns Mott, that "technically if you charge interest on a loan,
even to a family member, you are taxed on the interest -- even if the interest
is not being paid."
Loan interest can also be deductible
for borrowers starting a business.
Business-related loans are leagued
unto themselves, and it's essential to seek specialized tax advice.
If, for example, a borrower defaults, the lender can claim an allowable
business investment loss.
It's a good idea to make the loan
directly to the registered business, rather then the owner. Again,
legal documents defining terms, such as whether the lender is making
an investment or providing a loan, will prevent hassles in the long
There are times when lending money to loved ones
isn't a good idea. Lenders need to be financially stable and they need to have
faith in the borrower's ability and willingness to repay.
Don't be afraid to say no -- explaining
you simply can't afford it is less messy than demanding money from
a borrower who can't pay. If it's obvious that you have the money
but you aren't comfortable lending it, lie -- say your investments
are tied up, the market is bad or blame it on a lawyer, financial
adviser or accountant.
There are other options if you still
want to help, says Harris: "A far better alternative is to offer to co-sign
a loan." There's less pressure on the relationship, the borrower establishes
credit and there's a better chance the loan will be repaid.
vows to document any further loans to her son. But, even with proper measures
in place, lending money to loved ones is a gamble. As Shakespeare put it: "Neither
a borrower nor lender be. For loan oft loses both itself and friend."
Warren is a writer in Toronto.