Lending money to loved ones can be tricky. To avoid potential pitfalls and protect your relationships, treat the loan like a professional financial agreement. Here's a structured approach to make the process smoother:
Make It Official
Treat the loan as a formal agreement. Outline clear terms, including interest rates, payment schedules, and actions to be taken in case of default. A signed contract, possibly drafted by an attorney, ensures both parties understand their responsibilities.
Do Your Due Diligence
Ask for a full credit report from the borrower. Understanding their financial situation helps you evaluate their ability to repay. This also helps avoid lending to someone who may be seeking a temporary fix without addressing deeper financial issues.
Set a Fair Interest Rate
Familiarize yourself with Applicable Federal Rates (AFRs) to set a fair interest rate. Charging less than the AFR could have tax implications. The IRS updates these rates monthly, so stay informed and document everything for audit purposes.
Establish a Repayment Plan
Work with the borrower to create a realistic budget that includes repayment terms. Detail how much is owed, the frequency of payments, payment methods, and any grace periods. For borrowers with spending issues, consider adding a requirement for financial therapy to the agreement.
Include Incentives
Offer incentives to encourage timely payments. These could be financial, like forgiving the last few payments if the borrower is consistent, or nonfinancial, such as a special outing if the loan is repaid early.
Know When to Say No
If the borrower refuses to agree to your terms, or if you can't afford to lose the money, it’s okay to say no. Lending to someone without a plan for financial recovery can put both of you in a vulnerable position.
Following this framework helps protect both the lender and borrower while offering a responsible path to financial recovery.
At Mark Sullivan Consulting, we understand the complexities of lending money to friends and family. With years of experience navigating financial agreements and tax implications, we can help you structure a loan that protects your interests while maintaining your personal relationships. Whether it's drafting formal agreements, advising on interest rates, or providing tax guidance, our expert advisory services will ensure you make informed, secure decisions. Reach out today to get professional advice tailored to your unique situation and safeguard your financial future.
Request a free consultation HERE with Mark W. Sullivan, EA .
About the author
Mark opened Mark Sullivan Consulting, PLLC in October 2022 after a decade of tax consulting in FinTech. He is fairly new to the Phoenix area having moved here from St. Louis, Missouri in July 2020.
Mark has over 30 years of experience, including several years with the IRS as a Revenue Officer and over 16 years as director at a firm that specialized in civil and criminal tax accounting, IRS representation and forensic accounting. He has been admitted as an expert witness for civil and criminal tax cases in both State and Federal courts. Since relocating to Arizona and returning to practice, he has concentrated on tax compliance and planning for individuals and businesses, advisory and representation services.
He has an unlimited licensed to practice as an Enrolled Agent nationwide and is a member of the National Association of Enrolled Agents.
A long-time Jeep enthusiast, Mark enjoys off-roading in his 2006 Jeep Wrangler LJ around the Southwest or wherever he goes on vacation.
Copyright 2025 Mark Sullivan Consulting, PLLC.
Disclaimer: This article is for information purposes only and cannot be cited as precedent or relied upon in a tax dispute before the IRS.
Additional references:
"If You Really, Really Need to Lend Money to Friends or Family…", Jonathan I. Shenkman, The Wall Street Journal (October 16, 2024)
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