It is hard to think of anything more natural than lending money to a family member in need.
But while people tend to think of loans to family or close friends as a small, private matter, when viewed with a wider lens, intrafamily loans represent a massive sector – $89 billion a year in the United States alone, according to the Federal Reserve Board Survey of Consumer Finances. The scope of these loans ranges from miniature micro-loans – $100 to a teenager for a set of headphones, to be paid back with babysitting earnings – to more substantial loans to help a sibling get a new business off the ground, to major financing for a new car or home.
All in the family
Of course, there are good reasons that most people turn first to their families or close friends for financial help: Asking parents or siblings for money typically does not require borrowers to have a personal credit rating or to navigate the bureaucracy of a bank or online lender. Furthermore, family members are likely to be more forgiving than professional lending institutions when borrowers run into trouble keeping up with their payments, or conversely, would be unlikely to charge penalties for paying the loan back early.
But there are downsides as well. Intrafamily loans have a high rate of default – up to 27 percent, according to some estimates – due largely to the non-financial relationships that exist between borrowers and lenders. When paying back parents, children – even adult children – often do not feel a strong obligation to return money, and parents often do not want to risk alienating their children by demanding that they repay a loan. The old adage comes to mind, “those who lend money to friends and family risk losing both.”
Tools to lend to your tribe
A host of companies have entered this space in an attempt to streamline and formalize the process of intrafamily loans, in order to clarify matters such as interest and repayment terms between lenders and borrowers. ZimpleMoney provides a range of loan tracking services to manage single or multiple loans, loan calculators to help borrowers and lenders make informed decisions, and offers a series of template loan agreements, from simple parents-to-children loans to more complicated loan issues addressed by estate planning.
For mortgages, National Family Mortgage provides tax advice and registration services for intrafamily property loans for the purchase or refinancing of a home, equity loans or loans directed for home improvements. The company stresses that where possible, intrafamily mortgages serve to keep interest payments in the family. The claim is a convincing one to many people: The company says it has facilitated nearly $400 million in intrafamily loans, with an average interest rate of 2.78 percent and a total of sligthtly more than $177 million in interest payments inside family circles.
For smaller loans, and for loans granted to teenagers or to young adults, these services serve to professionalize the loan process and to establish clear expectations between lenders and borrowers. Many parents consider lending money to children an opportunity to educate them about money management. For them, online loan management technology clarifies the fact that the relevant transfer of funds is a loan to be paid back, rather than a gift, formalizing the transaction.
Looking ahead to intrafamily lending
Given both the scale of the sector, as well as the relevant tax issues governing estate planning, financial gifts and loans, intrafamily loans are often an effective choice, especially because interest paid on loans is typically lower than commercially-available loans, and because the interest paid on the loans stays in the family. First-tier financial institutions such as BNY Mellon help customers structure loan and gift plans. Online, Bankrate and ThinkAdvisor offer basic advice on intrafamily loans with regard to reverse mortgages and other inheritance issues.
Ultimately, however, the sector appears to be an under-developed corner of the financial services market. Of course, the internet is awash with printed advice regarding intrafamily loans, mostly provided by financial planners, journalists and banks. But with a global market stretching into the billions of dollars, it won’t be long before more start-ups and mid-level financial institutions begin to offer solutions for the sector.