With Mortgage and Other Rates Increasing, is a Family Loan an Option?

With interest rates noticeably higher than a year ago and still on the rise, the increasing cost of financing may be top of mind for some borrowers. A $600,000 30-year mortgage at 3.5% would amount to $2,694 a month. The same mortgage at 6.5% rises to $3,792; a 40% increase in monthly outflow. Declines in home prices may help blunt some of the interest expense on mortgages. But borrowing is nevertheless more costly and could impact the affordability of car purchases, business opportunities, or education in addition to homes. In this environment, an intrafamily loan, or family loan, may be good a tool to consider if the circumstances make sense.

What is an Intrafamily Loan?

An intrafamily loan is where one member acts as the bank or lender and another member is the borrower. The objectives include cost savings as well as ease of access to credit for the borrower. For the lender, interest can be earned and there are valuable non-economic benefits of helping family achieve a worthwhile goal. For both parties, the interest paid can keep wealth within the family, rather than go to a bank’s operating expenses and profits.

Should I Provide My Family A Loan?

Not everyone is in the financial position to be the family bank. To be comfortable as a lender, you should be sure your overall financial plan can facilitate the loan. Do you have the liquidity? Is the opportunity cost acceptable? And perhaps the most uncomfortable question within the family – is your borrower responsible?

Questions like these may not cause much anxiety if the loan is relatively small or over a short period of time. The risks are lower and the decision to help may be simple. But for large sums and longer time frames, it is more important to have clear terms and contingencies thought out. For example, what if the family member paying the loan back was let go from a job, or was disabled and couldn’t work? Similar to bank underwriting, a family lender should evaluate the risks and potential consequences.

How Can I Ask My Family for a Loan?

As the borrower, one could help by sharing the benefits of using the family loan compared to other options and having a clear plan for repayment. The more risks associated with how you are using the loan, or how you are paying it back, the more you should be prepared. After all, this is a loan, not a gift, and all parties should be clear on that point. A loan can successfully turn into a gift as part of a well thought out plan. But if a borrower is expecting relief via a gift and never gets one, that can sour even a tight family relationship.

In this article for Cashay, Heritage Financial’s Director of Financial Planning, Ed Jastrem, provides advice for family loan borrowers.

Think an Intrafamily Loan is Right for Your Family?

Intrafamily loans can assist family members and be used as an estate planning tool to pass on assets, but if not executed properly there are some financial and relational pitfalls to be wary of. It is wise to discuss your plans – as a lender or a borrower – with your wealth management team and bring in other professional advisors as needed. Intrafamily loans won’t be the solution to every borrowing need, but they have benefits worth considering, especially as traditional borrowing becomes more difficult.

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