Loaning Money to Family and Friends
Author: W. Dane Carey
Many people have or will lend money to other people in their lifetimes. Parents and grandparents frequently make loans to family members to enable them to buy a home, start a business, or enjoy some of the comforts of life. Sometimes friends lend money to friends. There are many contexts in which one person loans money to another person. No matter what context, however, it is always a good idea to put it in writing.
Loans made between family and friends frequently do not get reduced to writing. This is true for a number of reasons. In such situations, those making the loan sometimes feel it is too formal or perhaps even offensive to request that the other person agree to sign a written loan agreement. Moreover, they trust their family member or friend and expect him or her to honor their agreement to pay back the debt. This can present something of a problem in the estate planning area.
Issues usually arise many years after the money is lent, and often in the context of incapacity or death. For example, when a parent leaves his or her estate to the children equally, does that mean the loan should be treated as part of the child’s share? Or should it be forgiven? At that point, it is obviously too late to clarify the intention, and family members often find themselves in the position of fighting over the original intention, depending upon who benefits or does not benefit from one position or another.
This is the type of issue that pits siblings against one another after the passing of their parents. To avoid this regrettable scenario from taking a toll on your family, we strongly suggest that grandparents and parents should consider addressing the issue or loans in their wills or trusts. These documents should specify that loans made to family members should be forgiven if not paid or treated as part of the borrower’s share.
Similarly unfortunate results arise in any context when loans are not put in writing, regardless of whether the loan is made to children or other family members or friends. Does this scenario play out for everyone? No. But it happens all too frequently, and it is something that can be easily avoided by documenting the loan.
Here are just a few reasons why you should always put the terms of your loan in writing:
Reason 1—Avoid Misunderstandings: If your conversations with family and friends are like most, different ideas get kicked around. Eventually you come to an agreement. Or did you? How much was the final amount again? Was it being provided all at once, or over time? Is it a gift, a loan, or some of each? Is interest being paid—and if so, how much and how often? Is part of the principal being repaid periodically, or is it due all at once, or is it open-ended? Putting the terms in writing will ensure that everyone knows what the arrangement really is.
Reason 2—Make Sure No One Forgets: In addition to sometimes misunderstanding one another, over time, family and friends can also simply forget exactly what it was that they agreed to. Having the agreement in writing can save a lot of arguments down the road. Yes, sometimes borrowers even forget that they borrowed money at all! A written agreement protects everyone. And if it is a loan to be paid off, the agreement should be marked PAID and returned to the borrower when that happy day arrives.
Reason 3—Proof for Others: As discussed above, documentation of the loan is often necessary to avoid problems among siblings during estate administration. But having evidence of the loan is also important in other situations. Let’s say you lend agree to lend $5,000 to your best friend so he or she can start a business, and you do so on a handshake basis. Let’s also say, hypothetically of course, that you die a few years later and your spouse and children need to start getting repaid on that loan. Does your spouse even know about it? Does he or she remember? Is there any proof that the transaction ever occurred? Or let’s say that your best friend dies, and his or her spouse sells the business at a nice profit. Does he or she know about the $5,000 loan? Does he or she care? They will if you have a signed agreement. Simply putting the loan in writing can save everyone a lot of grief.
Needless to say, the moral of the story here is that you should always put your loans to family and friends in writing. This does not necessarily mean you need to have a complicated legal agreement drawn up—though, that may be the case in some situations. Rather, the loan agreement can usually be simple and straightforward, stating the date of the loan, the amount, any terms, and the fact that it must be repaid.
If you have any questions or concerns regarding loans to family and friends, feel free to contact the experienced estate planning and transactional attorneys at Dingeman & Dancer.