Lending money to family can be fraught with danger. Firm ground rules should be set to avoid disputes. You should also consider how making the loan will affect your financial situation.
Your son or daughter has come to you for financial help. Your parental instinct kicks in and you want to assist, but you are cautious – you’ve heard horror stories of money driving a wedge between family members.
So, what factors do you need to consider when making loans to family members?
Set ground rules (terms of the loan)
From the outset, everyone should be clear on the terms of the loan.
These can include:
- the length of the loan (duration)
- the loan amount
- whether any interest will apply to the loan
- the frequency of repayments
You could even spell out what would happen should a repayment be missed, such as penalty interest. This may sound a bit heavy-handed when dealing with family, but the more bases you cover from the outset, the less room for disagreement down the track. If you leave terms open-ended and informal, there is a greater chance the money won’t be repaid within a reasonable time frame.
Put it in writing
You need to have the terms in writing and have a loan agreement drawn up. This provides clarity and protects you should things go sour and the need arise to recover the money. With nothing in writing, it is difficult to prove your claims in a dispute.
Talk to your accountant
Contrary to what many believe, any interest received from a loan needs to be declared to the tax office. The fact that it’s a family member you’ve made the loan to doesn’t change this. Best to speak to your accountant to confirm any tax implications.
How will the loan impact on your pension entitlements?
If you’re receiving benefits from Centrelink such as the Age Pension, they’ll need to know of any loans you make. Why? Well, put simply, the loan is still considered a financial investment and is subject to the deeming rules.
What is deeming?
When it comes to assessing income from your financial investments, the Government assumes that you will be earning a certain rate of return, regardless of the actual interest rate that you receive. This system is known as deeming.
This means that even if you decide to make the loan interest-free, you will still have some income assessed against your pension.
What if the money is not repaid?
If the money is unable to be repaid, it can cause a myriad of issues. The most obvious is that it could put your own finances in jeopardy if you don’t have the money to spare.
If you have to forgive the loan, the funds will be treated as a gift for Centrelink purposes and this could impact your pension entitlements. For more information on gifting, please see How much can you gift?
Lending money to family should be approached with a degree of caution. There are many implications beyond just the transfer of funds to consider. If you have reservations about the person’s ability to stick to an agreement and repay the loan, you should say no.
Money is one of the biggest causes of family disputes, so refusing the loan — no matter how difficult that may be — could ultimately save your relationship.
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