Family loans need written agreements

Arranging a loan between friends or family members can be tricky.  Honesty is usually the best policy, but careful attention to detail also can help.

Experts urge you to draw up formal papers that spell out a precise interest rate and payment schedule.

These can't be just random numbers. The rate must meet the legal minimum, called the applicable federal rate, or AFR, says Anthony K. McEahern, senior vice president and national director of Wells Fargo Bank's Wealth Planning Center in Denver.

The AFR is changed every month or two by the IRS. Currently, for loans of three years or less, that minimum is a low 0.83 percent. For those between three and nine years, it's a yearly 2.15 percent. Loans that go nine years or longer must carry a minimum annual interest rate of 3.67 percent.

The loan agreement can further stipulate that you pay no interest for a period of time, or make no payments at all until a certain threshold is met. In any case, the friend or relative who lends you the money will have to pay taxes on the interest, McEahern says.

If you own your home, you may be able to use it as collateral even though your lender is a loved one. This makes the loan more like a second mortgage. You'll be able to deduct the interest payments from your taxes. But if you fail to make a payment, your friendly lender might be able to seize your property.

You may want to have an attorney draw up the appropriate papers.

Is it time to tap your rainy-day fund? See "Tapping savings in hard times" for more information.


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