I don’t know about you but this recession of 2008 to 2009 is really killing me! Unemployment is shooting through the roof and the credit markets have completely frozen and aren’t showing any signs of thawing anytime soon. The government has bailed out the banks, and they have a lot of money to lend out… the problem is, they’re not lending!
This has led to the need for creating alternative ways of borrowing money. In some cases we’ve seen an increase of lending between friends and family members. There’s absolutely nothing wrong with borrowing money from a family member or friend, as long as you do it correctly and avoid these pitfalls that I’m going to discuss in this article today.
There’s nothing wrong with lending money to a friend or family member, but you need to maintain certain formalities in order to make the loan legal in the eyes of the IRS. This means mostly that you have to charge interest. Not only do you have to charge interest, but you have to charge a certain rate of interest, otherwise the IRS will consider the loan a gift and tax you on it. Back in the old days before 1984 parents could make interest-free loans or below market interest rate loans to their kids, but not anymore.
There are some exceptions, if you make a loan of $10,000 or less to family or friends, generally speaking you can get away with charging low or no interest as long as your family member or friend doesn’t use the loan to invest in something. It’s important to note that the number of loans is not important, what is important is the total amount that you’ve loaned to a single person. So don’t think you can get around the $10,000 limit by loaning the person four loans of $5000 each. The IRS adds all the loans together and sees that you’ve loaned them $20,000 which is above the limit for no interest rate loans.
So what interest rate should you charge them? Generally speaking you have to charge them the current market interest rate, or the IRS interest rate. You can find this rate by running a search on the IRS website at any given time. Another pitfall to avoid is charging too much interest. Believe it or not, most states have laws against usury, which is charging too much interest. Depending on your state, the interest rate may be as low as 9%. That means that you cannot charge more than 9% in interest, legally speaking. Check with your specific state because every single state varies. This is why, if you’ve ever wondered, most banks and credit card companies are headquartered in Delaware. Delaware has very high usury interest rates, which is how credit card companies get away with charging you 20 or 30% interest.
To find out your state’s usury interest rate limit, run a search at Google. Just type in your state’s name and the words “usury interest rates” and you’ll find a list really quickly.
We may be in a recession, but we still need to pay for things that we don’t always have the money to do it. Loans from friends and family members are sometimes the last option available to us. Just be sure you follow these few tips, and you’ll be just fine.