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Making a loan to family or friends?

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Making a loan to family or friends?

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1. Ask before lending

Many grandparents who mean well can offend family by lending money without asking. A financial gift to a grandchild can be misunderstood by your grandchild or their parents or guardians. While many families will welcome the help to pay for college, always ask before making loans to grandchildren.

2. Consider the tax consequences

Depending on how you structure the loan, the IRS may view it as a gift. According to current IRS regulations, you and your spouse each have the freedom to give up to $15,000 each year to anyone as a gift without paying gift taxes. If you give more than this, then the gift will be considered part of the $11.7 million per person limit you can give away without paying gift or estate taxes.

However, if you structure the loan properly, it may not impact your tax liability. This is where talking with a lawyer can be helpful. In general, you need to charge interest and document the loan to avoid having it viewed as a gift for tax purposes. Also, you need to report the interest income on your tax return to avoid penalties.

3. Always have a contract

Sure, you trust your grandkids to repay what is owed, but if you are serious about getting the money back, make sure you ask for a signed contract. Consider holding collateral, if possible, so that your grandchild  is motivated to repay in a timely manner.

This can be challenging because many college students do not have meaningful assets to use as  collateral. However, setting up a Promissory Note or Payment Agreement, with a required monthly payment amount, is a good way to hold your grandchild accountable. A written contract can ensure that problems with family members won't arise later. 

4. Make monthly payments reasonable

When setting up the Promissory Note or Payment Agreement, make sure that you require a monthly payment that is not too high for a college student's limited budget. Simply saying, "Pay what you can afford" will often end up meaning you get nothing.

5. View this as a life lesson

Loaning your grandchild money to use for college is an excellent way to teach money management skills without wide-ranging credit implications in the event of default. This is an opportunity to teach your grandchild about money and how it works in a safe, protected environment. Not only will the young person you love get their college education, but they will also get a real-world education in borrowing and lending.

6. Know your options

Before lending to grandchildren, know how to get the money back if they decide not to repay. If you have a contract, then the loan may be legally binding. You could take your grandchild to small claims court or repossess any asset they put up as collateral. However, you have to be willing to do that. Otherwise, you may lose the money you loaned them.

Loaning money to your grandkids is perfectly legal and can provide important financial help. However, before you do, you will want to make sure you understand the financial and legal implications. You may want to discuss these options with a lawyer or finance professional before making a decision, but do not be afraid to use your wealth to bless your grandchild's college years. If you have questions specific to your situation, reach out to a Rocket Lawyer On Call® attorney for affordable legal advice.

This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.

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