Should You Borrow Money From a Family Member?

In the past, to pay for unexpected expenses like a broken-down car, a burst pipe, or emergency dental surgery, you may have taken out a personal loan or run up your credit cards. But this time, you've got a different financing plan in mind: a family loan.

You would hardly be the first to use the family or friend financing option. According to the Consumer Protection Financial Bureau, as many as one in five U.S. adults receive financial support from friends or family. Lower interest rates, no credit checks, and flexible terms tick all your financial boxes. What's not to like?

But before you commit to this course of action, be aware that mixing money and relationships can be a relationship-breaker if you don't go about your family business in the right way.

And if you decide that asking family for a loan is a bridge too far, you've got alternatives.

What is a family loan?

Instead of turning to traditional lending sources like a bank, credit union, or online lender, you ask a family member for the money (or you provide funding for a relative in need). The money is not a gift. Rather, it's an arrangement that ideally benefits you and your lender. For example, you may receive an interest rate less than you would pay commercially, and your lender may receive an interest rate higher than a savings account or CD might pay — a classic win-win.

Another silver lining: All interest stays in the family.

"Why give it to a bank?" asks Sonal Bagga, founder of Namma, a New York City-based company that structures loan agreements between borrowing and lending family members.

For affordability and simplicity, family loans might seem hard to beat, but before asking a relative for their help with financing a new car, home, or other project, know that you could draw scrutiny from outside the family — namely the IRS.

Family loan rates and tax implications

The IRS generally cares little about "gift loans" under $10,000 — whether interest, if any, is charged, or even if you fail to pay back the loan. In their eyes, that's your and your family's business.

However, if the loan amount tops $10,000, the IRS will want to make sure the loan isn't a tax dodge. Lenders generally must charge an interest rate equal to or greater than the Applicable Federal Rate (AFR) to avoid tax consequences. Quoted AFRs appear in three tiers: short-term (under three years), medium (three to nine years), and long-term (over nine years).

If you begin repaying your loan with interest, your lender may have to report the interest as income. So, at least as far as your family lender is concerned, granting you a loan may not be as simple as cutting you a check and moving on.

If the lending family member charges no interest for the loan or an interest rate under the AFR minimum, the IRS could treat the amount as a gift, not a loan, or charge tax on any foregone interest. (Foregone interest is the amount the lender would have received at the appropriate AFR.)

2024 and 2025 gift tax exclusion amounts

The IRS gift limit for 2024 is $18,000, with the limit increasing to $19,000 in 2025. Amounts that exceed the gift limit must be reported with the lender's tax return, which will count toward the lender's lifetime gift limit ($13.61 million in 2024). Unreported gifts could result in penalties to the lender, even if no tax is due.

Pros and cons of family loans

As a borrower, you get easy access to a low-interest, flexible-term loan without having to jump through a bunch of credit, income, employment, and other bureaucratic hoops to qualify. Meanwhile, your lender gets the satisfaction of both helping you and collecting interest on money that may have been just sitting or collecting a very low interest rate at a bank or credit union.

However, it's important to consider the potential emotional and financial costs. Also, for large loans not structured correctly, there could be tax consequences. Whichever way you're leaning, approach your decision with great care.

How to create a family loan agreement

"We draw up family loan contracts all the time," says George Pfeiffer, a partner at Pfeiffer Law in Walnut Creek, Calif. "It's a simple promissory note that covers all the basics. If the loan is ever called into question, you've got the document."

If the total loan amount is fairly small, downloading and completing a simple family loan form from Lawdepot.com, legalcontracts.com, eform.com, or a comparable online provider may be all you need to document your agreement. For larger personal loans, however, you may feel more comfortable hiring a family law attorney or services like Namma or National Family Mortgage, which facilitate intrafamily loan agreements.

Each promissory note has its own unique set of terms and conditions, but most will include the following basics:

• Name and address of borrower and lender
• Maturity (payoff) date
• Sum borrowed (amount loaned)
• Loan's interest rate, if charged, and how interest is calculated
• Repayment schedule or frequency (usually monthly)
• Interest charged or other penalty for late payments
• Prepayment penalties, if any
• Default consequences (contingencies, collateral, etc.)

A promissory note is a simple, straightforward, and effective way to spell out the terms and conditions of the arrangement between the lender and borrower. When both parties clearly understand the expectations set forth, they may be more likely to live up to them.

Listing the purpose of the loan is optional. "You do not need to put a purpose in the note," Pfeiffer adds. "However, you should indicate that the borrower has, in fact, received money or other consideration for which he or she is paying back the lender."

Is borrowing money from a family member a good idea?

Upfront, the idea of a family loan has a lot of appeal, especially for borrowers: less hassle, less paperwork, less formality, and you still get the money.

But longer-term consequences can rear up. Say, a family member loaned you money but you lost your job or made some bad financial choices. What looked good initially — that easy-money loan from a trusting relative — could get complicated.

Yet, if both parties know and accept the risks and confirm their agreement formally, beyond a hug or a handshake, it can still be worth pursuing.

Alternatives to family loans

Before pulling the trigger, consider a few alternatives.

Cosigning

You apply for a loan from a bank, credit union, or online lender, and a family member or friend with good credit serves as your cosigner. If you miss payments or default, the cosigner is responsible for repaying the loan. Cosigners don't put up any cash initially (or, ideally, ever), but they're still taking a risk on you.

Check Out: Best Personal Loans With a Cosigner

401(k) loan

A little more than 1 in 3 working age individuals (ages 15-64) have a 401(k)-style retirement account. If you're one of them, you can typically borrow up to 50% of your 401(k) funds or $50,000, whichever is less. If your vested balance is under $10,000, you can borrow up to $10,000, though plans aren't required to permit the exception.

Most plans give you five years to repay a 401(k) loan (as long as you stay with your employer). The principal and interest you pay back goes back into your account. What doesn't return to your account is the lost time during which those temporarily absent funds could have grown.

Compare: 401k Loan vs. Personal Loan

IRA withdrawal

While you can't borrow from an IRA, you can take penalty-free withdrawals if you are 59½ or older. If you're younger, you might qualify for an IRS exception (without the 10% additional tax penalty). Exceptions may include withdrawals for:

• Qualified first-time homebuyers (up to $10,000)
• Unreimbursed medical expenses (more than 7.5% of your adjusted gross income)
• Qualified higher education expenses
• Disaster recovery (up to $22,000)

Note that you'll still owe taxes on amounts withdrawn from a traditional IRA.

If you have a Roth IRA, you can withdraw contributions without penalty at any time. Earnings can be withdrawn from a Roth without penalty for the exceptions noted above.

Margin loan

If you have a margin account with your broker, you may be able to borrow up to 50% of the value of the securities in it to purchase more financial products, like stocks, bonds, and mutual funds, or for non-investment purposes. Margin loans typically have lower interest rates than personal loans or credit cards.

Be aware, however, that if the market declines and you get a margin call, you may have to deposit additional cash or securities in your account to cover market losses. Your broker may even be able to sell your securities without notice.

Securities-backed line of credit (SBLOC)

An SBLOC also allows you to borrow against the value of assets in your brokerage account. It's a revolving line of credit that you can use for just about anything, except buying or trading securities. You may be able to borrow between 50% to 95% of the value of the assets in your account, and interest rates are often lower than those of personal loans or credit cards.

"SBLOCs can provide investors the cash they need without having to liquidate any of their holdings," says Ken Robbins, a Raymond James wealth advisor in Pasadena, California. "This way, investors can stay invested in the market without triggering potential capital gains taxes on the sale of securities that have gained in value."

At the same time, an SBLOC involves a risk similar to a margin loan. If the value of your assets decreases below a certain threshold, you might have to repay part of the loan or post additional collateral, or the investment firm could sell your securities.

Gift

You could ask a family member for an outright gift of money, generally without having to declare it as income. If the amount is larger than the annual exclusion threshold ($18,000 for 2024 and $19,000 for 2025), the giver must report the gift to the IRS. Gifts that exceed the annual limit will be subtracted from the giver's lifetime gift exclusion.

Explore: The Best Ways to Borrow Money

Read More:

• Should I Get a Personal Loan?
• How Do Personal Loans Work?
• What Credit Score Do You Need for a Personal Loan?
• How Much of a Personal Loan Can I Get?
• How Long Does It Take To Get a Personal Loan?
• Personal Loan Term Length: What You Need To Know
• What Are Personal Loans Used For?
• What Can't You Use a Personal Loan For?