6 tips on borrowing from relatives
When people find themselves in a money crunch, a natural
reaction is to turn to family for help. Parents, grandparents
and siblings often are happy to lend a financial hand via a loan.
But unless handled carefully, family
members -- not just the relative advancing the cash, but others -- will
"There's no such thing as a family loan without emotional
ties," warns Azriela Jaffe, entrepreneur and author. "If you don't
understand that from the beginning, it will take you by surprise."
Jaffe says borrowing money from parents, the most common scenario,
can put you back in the same place you were when living under their roof. "Mom
and dad are paying the bills, and they feel entitled to tell you what to do.
All of a sudden you are 13 again and rebelling."
Faced with the need to rely on some all-in-the-family money, how
do you minimize the potential for resentment and destructive situations? Here's
some advice from people who have been there.
Know from whom you borrow
Houston bankruptcy attorney John Ventura says before you
seek a loan, analyze your relationship with the lender. Ask yourself, "If
I lose the money, what will be the outcome?" Relatives for whom money is
an obvious emotional issue or those who really can't afford to lose anything
are not good lending candidates, he says. Moreover, you put people in a tough
spot when they have to turn you down, creating hurt feelings all around. When
you ask, be prepared to handle a refusal graciously.
Seek a co-signer
If the bank will accept a parent or relative's signature
on the note as a guarantee, go that route. Tom Gillis, Houston lawyer and CPA,
put up bonds as collateral and signed his son's notes twice when the younger
man opened a heavy equipment manufacturing business. "It's much more businesslike,"
says Gillis. "The bank drew up all papers. All I had to do was sign my
name." The good news is that eight years after the first loan was made,
Gillis' son brought over a bottle of champagne and the paid-off notes.
Put everything in writing
It may be sufficient in a very simple transaction to write
a letter that specifies the terms of the agreement. But the best way may be
to get a lawyer involved, particularly if it is a significant sum of money.
That protects both sides. "Give your family the same respect that you'd
give a professional lender," says Jaffe, author of the Complete
Idiot's Guide to Beating Debt. "In return, that
increases the chances they'll treat you with respect."
Know the tax laws
If the loan is for less than $10,000, it will probably escape
the IRS' attention. But if your family loan is for a significant amount, make
sure you understand the tax and other legal consequences, particularly if the
lender dies before the loan is paid off. The IRS considers loans that are forgiven
as taxable income. James Walsh, an insurance consultant and author of Family
Money, suggests insuring the lender's life for the
amount of the loan as one way to guarantee repayment and avoid tax problems.
Give lenders something tangible
Specific collateral for either co-signers or lenders will
ease concerns and ensure that they don't lose everything if things don't go
well. Bankruptcy attorney Ventura says that if you are forced to file bankruptcy,
provided you've structured the agreement properly, your lender will have a lien
on your house or your car. That will put them at the top of the list of creditors.
"You and your relative will get peace of mind. And if you have a close
enough relationship and the item is repossessed, chances are it will just be
given back to you," Ventura says.
Tell the world your business
You may think the financial deal is just between you and
dad, but family secrets are hard to keep. Siblings, in particular, are likely
to be concerned about loans from parents. Gerald LeVan, managing director of
LeVan Co., family business consultants based in North Carolina, recommends telling
other close relatives how much you're borrowing, why you're doing it and then
keeping them posted about how your financial affairs are going. "It cuts
down on the feelings of favoritism and jealousy," he says.
Jennie L. Phipps is a contributing
editor based in Michigan.
-- Updated: Jan. 12, 2004