It’s the holiday season once again, and that means spending more time than usual with your family.
Apart from the stress that typically comes with all that holiday cheer, you may also get hit with another kind of awkwardness — a request for a loan. Maybe your niece needs help paying for college, or your cousin needs some cash for a down payment on her condo.
Lending money to family members can be a minefield. Here are five things you should consider before making your decision.
1. Can you afford it?
It can be hard to see a loved one struggle financially, but be realistic about your own ability to lend them money. Will lending the cash mean that you will have to put some of your own plans on hold? If so, are you willing to make that sacrifice?
2. What will the money be used for?
Even if you have the money to spend, you don’t want to enable bad habits. Only lend money if it’s going to be spent toward a specific goal or purpose that you’re comfortable with. As Suzanna de Baca, vice president of wealth strategies at Ameriprise Financial puts it in this Wall Street Journal article, “If you have a relative and you really don’t approve of what they’re asking for or feel that it will enable irresponsible behaviour, you should think twice about extending money to them.”
3. Is it a loan or a gift?
Will the money you give be a loan that you charge interest on, or a gift? If it’s a loan, the IRS requires you to charge an interest rate equal to or greater than the applicable federal rate, which is set monthly and is usually lower than the market rate. You will also be taxed on any income you make from these loans.
If it’s a gift, keep in mind that you will not be taxed on any cash or assets you gift under the annual exclusion of $US14,000, or $US28,000 if you and your spouse are giving the gift together. If the gift amount is over $US14,000, you will pay taxes on the interest you’ve waived.
4. Get everything in writing.
If you’re going the loan route, guard against any potential disagreements by getting the terms of the loan in writing, such as the amount, interest rate, length of the loan, and the repayment schedule. Be sure to also note whenever any amount is paid back.
5. Be prepared to lose your money.
Lending money to the people closest to you is almost always losing proposition, Jeff Leventhal, managing director at HighTower in Bethesda, Md., told WSJ. Family members may ask you for a loan because they’re looking for lenient conditions. So unless you can deal with the prospect of never seeing your money again, don’t make the loan at all.