9 legal tips for lending money to family and friends
Navigating the complexities of personal loans between family and friends can be challenging, but with expert guidance, it becomes manageable. This article strips back the confusion, presenting clear advice from legal professionals to help secure both relationships and finances. Insights cover everything from contracts to tax implications, ensuring readers have the knowledge to make informed decisions.
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- Draft a Legally Binding Contract
- Specify Loan Terms in Estate Planning
- Define Loan Terms in Writing
- Consider Tax Implications of Loans
- Use Promissory Notes for Personal Loans
- Understand Statute of Limitations on Loans
- Formalize Agreements for Family Loans
- Plan for Financial Difficulties in Loan Terms
- Comply with State Lending Laws
Draft a Legally Binding Contract
When lending or borrowing money from friends or family, one crucial legal aspect to consider is the creation of a legally binding contract. While it might feel awkward to formalize a loan with loved ones, treating it like a business transaction is essential to protect everyone involved.
Without a written agreement, the loan could be misconstrued as a gift, leading to misunderstandings and potential legal disputes, especially if the relationship sours. In family law, we often see these informal arrangements become sources of conflict during divorces or estate settlements, where the nature of the transaction becomes a point of contention.
Therefore, my tip for ensuring clear communication and avoiding legal disputes is to draft a simple loan agreement. This document should clearly outline:
- The loan amount: How much is being borrowed?
- The repayment terms: When and how will the money be repaid? Will there be installments or a lump-sum payment?
- The interest rate (if any): Is interest being charged? If so, what is the rate?
- The consequences of default: What happens if the borrower fails to repay the loan?
- Signatures from both parties: This confirms that both the lender and borrower agree to the terms.
Even a basic written agreement, signed and dated by both parties, provides a clear record of the loan and its terms. This simple step can prevent significant headaches and preserve relationships. It’s also advisable to keep any written communication regarding the loan, such as email or text messages, for your records. If the amount is substantial, it may be prudent to seek the help of an attorney to draft the loan agreement.
Duane Coker, Attorney & Founding Shareholder, Coker, Robb, and Cannon, Family Lawyers
Specify Loan Terms in Estate Planning
One of the most commonly overlooked legal aspects of lending or borrowing money from friends and family is how it can affect estate planning. Many people think that an informal loan will just sort itself out over time. However, if the lender passes away before the loan is repaid, things can get tricky. Without clear documentation, the borrower might claim that the loan was actually a gift, while the lender’s heirs or estate executors could insist that it needs to be paid back. This can lead to disputes, delays in probate, and even legal battles.
To avoid these complications, it’s wise for the lender to specify in a will or trust how any outstanding personal loans should be treated. Should the loan be forgiven upon death, or should it be deducted from the borrower’s inheritance? If there are multiple heirs, not clarifying this can lead to unfair situations—one person might benefit from a forgiven loan while others see their inheritance reduced. Having a formal agreement, even for loans between close family members, promotes transparency and helps prevent misunderstandings.
For effective communication, it’s best to discuss these terms openly when the loan is made. A simple written agreement that outlines repayment terms and what happens if circumstances change (like disability or death) can clear up any confusion later on. Regular financial check-ins can also help ensure that both parties are on the same page and allow for adjustments as needed.
By addressing estate planning in personal lending, both parties can safeguard their financial interests and reduce unnecessary stress for their families in the years to come.
Bob Schulte, Founder, BrytSoftware LLC
Define Loan Terms in Writing
The legal status of the money must be clearly defined in writing. If it is a gift, then call it one. If it is a loan, then specify repayment terms in dollar amounts with exact due dates. Oral agreements over money often fail because memories compete under stress. A signed promissory note can prevent years of friction. That document should list the principal amount, repayment schedule, interest if any, and default consequences in plain language. A $2,000 misunderstanding has broken households. A three-page agreement would have solved it.
Communication should be written and dated from the start. Texts or emails confirming the loan, repayment plan, and reason behind it can provide evidence if disputes arise. Never rely on assumptions or casual understandings. If you cannot summarize the terms in writing, then you are not ready to exchange money. One written agreement will carry more weight than twenty conversations. Clarity is not rude. It is protection.
Shane Lucado, Esq., Founder & CEO, InPerSuit™
Consider Tax Implications of Loans
Tax implications are often overlooked but can become a significant issue. For example, if you lend money and don’t charge interest, or if the interest rate is below what the IRS considers the “applicable federal rate,” it could be treated as a gift, triggering gift tax rules. On the flip side, if you’re borrowing, any forgiven debt could be treated as taxable income. These are details people don’t usually think about, but they can cause problems later if not handled properly.
Treat it like a business transaction, even if it’s personal. This means discussing not just the terms of repayment but also what happens if someone can’t pay, whether that’s restructuring the loan or agreeing on consequences upfront. It’s uncomfortable to talk about worst-case scenarios, but being proactive about them ensures there’s no ambiguity if things don’t go as planned. That clarity is what keeps relationships intact and disputes at bay.
Paul Carlson, CPA & Managing Partner, Law Firm Velocity
Use Promissory Notes for Personal Loans
A few years ago, I lent a close friend $12,000 to help bridge a career transition. We trusted each other, so we skipped formal paperwork. But come tax season, my accountant flagged something I hadn’t considered: because we didn’t charge interest, the IRS could treat part of that money as a taxable gift under federal rules.
That was my crash course in the Applicable Federal Rate (AFR)—a legal requirement that loans over $10,000 charge a minimum interest rate. Without it, the IRS assumes you’re gifting money and may tax the difference. It was an eye-opener that a good deed could trigger unintended tax consequences.
Since then, I’ve made it a rule to draft a one-page promissory note, even with close friends or family. I keep it simple: amount, interest rate (at or above the AFR), repayment schedule, and what happens if someone misses a payment. We sign it digitally, and I use a shared Google Sheet with a built-in amortization table so both of us can track the balance live. No confusion, no awkward reminders.
The biggest lesson? Treat personal loans with the same clarity you’d expect from a bank. It protects relationships, ensures legal compliance, and removes all the stress of second-guessing each other down the line.
Ahmed Yousuf, Financial Author & SEO Expert Manager, CoinTime
Understand Statute of Limitations on Loans
One important legal aspect to consider is the statute of limitations on personal loans. In many jurisdictions, if a lender does not take legal action within a certain number of years after the borrower defaults, they may lose the right to enforce repayment. This becomes particularly problematic if the loan wasn’t documented or if the borrower stops making payments years later. Having a signed agreement with clear repayment dates helps reset or clarify this legal timeline, protecting the lender’s rights.
To prevent misunderstandings, a great tip is to use a third party or digital tool to track payments and terms. Platforms like Venmo or Zelle, combined with a shared spreadsheet or payment tracking app, can help keep both sides accountable and transparent. This removes ambiguity, documents repayment progress, and reduces the emotional strain that often comes with informal loans—ultimately making the arrangement more professional and less likely to end in conflict.
Rose Jimenez, Chief Finance Officer, Culture.org
Formalize Agreements for Family Loans
Working with my dad has given me firsthand experience in navigating both the emotional and practical sides of working with family—and that extends into finances too. Whether it’s investing in a new facility, expanding services like climate control, or covering upfront costs during the off-season, we’ve had to be very intentional when lending or borrowing money between ourselves.
One legal aspect that’s essential in these situations is having a written agreement in place, no matter how much trust exists. A promissory note or loan agreement that clearly outlines the amount, repayment terms, interest (if any), and what happens in the event of a default protects both parties. It might feel overly formal when dealing with someone you care about, but it removes ambiguity and keeps the relationship strong by setting shared expectations.
One tip I’d give for ensuring clear communication and avoiding legal disputes is to treat the process like a business transaction from the start. Have a face-to-face conversation, lay everything out clearly, and then follow up in writing. Even if it’s just an email recap before drawing up the paperwork, that written trail can help everyone stay on the same page. It also opens the door for both people to ask questions and clarify points early—before any issues can arise down the road.
The key is transparency. Just because there’s love or loyalty in the relationship doesn’t mean you skip the structure. The structure is what helps protect that relationship over time.
Sarah Bosworth, Customer Success Manager, JMC Self Storage
Plan for Financial Difficulties in Loan Terms
When lending or borrowing money between family or friends, it’s important to consider what happens if a party experiences financial difficulty. Often, one side will feel uncomfortable asking for an extension or adjustment to the terms. Legally, this could lead to a situation where repayment isn’t feasible, and no clear understanding exists of what happens next. Clarifying what would happen in such circumstances upfront is essential.
A tip to avoid potential disputes is to discuss alternative options for repayment before the loan is made. This could involve allowing the borrower to make smaller, more manageable payments if they experience financial setbacks. It might even involve an agreement where the lender agrees to adjust the terms if needed. Having these conversations ahead of time can save a lot of stress later on, ensuring everyone understands what happens if things don’t go as planned. It’s about creating flexibility and setting realistic expectations from the beginning.
Mark Sanchez, Founder & Senior Real Estate Manager, Tropic Residential
Comply with State Lending Laws
When it comes to making money transactions lawfully, the applicable state laws defining the maximum allowable interest rate on person-to-person loans are a prerequisite legal consideration. These rules regulate both lenders and borrowers. Informal loan suppliers have to be careful not to exceed local boundaries in charging interest, as in most situations, such exceeded interest will render a loan uncollectable and entail financial sanctions. All lending arrangements have to comply with local lending laws so that all parties are safe.
To mitigate the chances of miscommunication, a loan agreement with a dispute clause should ideally be made. The most important protective provision for both parties is a written loan document stating the amounts lent, payment terms, interest (if any), and additional protection clauses that define possible disputes, such as mandatory mediation. The predefined dispute resolution procedure enables parties to safeguard their relationships while managing their expectations.
Bhavin Swadas, Founder, Mine My Deal
