Everything You Should Consider in a Family Loan Contract

Lending money among family is a practice that has been around forever, but it is smart to make it official with a written loan agreement to protect against issues that could arise later on. Here are some things to consider when drafting an agreement between family members.

Specify the Loan Terms

When thinking about a loan contract, consider everything that a third party would need to know to understand the transaction from the initial loan to full repayment. Include all important information like the name of the person lending and the person borrowing, the loan date, the payment plan, the interest rate, and what happens in the event of a late payment or default.

Minimum Loan Interest Rate for Family

There are some IRS rules regarding the minimum interest rates that must be considered when family members lend each other money. If the rate of your loan is too low or nonexistent, the IRS could find that is is not really a loan at all, but rather a gift, and seek to collect taxes due. However, this only applies to loans of a certain size. A very small loan to a child is not going to trigger the tax. Still, to avoid this, consider setting an interest rate that is not unreasonably low, and check the IRS site for current thresholds. Generally speaking, an interest rate that is modestly lower than what you might find at a bank is more than safe.

Protecting Estates of Older Lenders

When family is involved, often times an older parent or grandparent is the lender. Consider carefully what might happen in the event of a death. Examples of a resolution could include anything from the end of the repayment schedule to paying another party or paying the estate. Consider the impact on inheritance or other factors should this become a reality.

Witness for Family Member Loans

Both the lender and the borrower should sign and date the final agreement, but it may make sense for a third party to witness and sign the agreement as well. This might be another family member, friend, or even a notary at the local bank branch.

Loan Agreement Template Sample

Here is a brief template that includes the basic information needed in a loan agreement. You can see that it covers who loaned money to whom, how much, when, at what interest rate, and how it is to be repaid. 

LOAN AGREEMENT: The borrower, Harold Doe, agrees to pay the lender, Jim Doe, the loan amount of $1,000 plus interest at an annual rate of 4%.  This loan was made on July 1, 2014. Payment will be made by personal check in 12 monthly installments in the amount of $85.15 and will be due on the first of each month beginning August 1, 2014 and ending on July 1, 2015. A fee of $10 shall be due along with the normal payment amount for any payment that is more than 15 days late. In the event of the death of the lender, remaining payments shall be made to Val Doe until the loan is paid in full.

At the bottom of this loan agreement, the signature section should be added, including the printed or typed name of the borrower and lender, along with each of their signatures and hand-written dates of signing.

More Details Are Better

Any written agreement that is clear about the loan terms is good enough to make it official, but adding even more details and setting expectations of both parties may avoid sticky situations later. For example, declaring exactly how the payments will be transmitted may make sense. 

Also, providing for a full prepayment at any time to save further interest or for extra principal payments along the way are common things that may be added to offer greater flexibility to the borrower, but they must be considered ahead of time so that there is no need to renegotiate in the middle of the loan term

The family loan can be a powerful way for siblings or children to get access to needed money. As long as a loan contract is drafted and signed properly, this loan can be completed with relative ease in a way that protects the relationships of the family members until it is paid in full.