The importance of documenting family loans.
A 2019 Bankrate survey found that sixty percent (60%) of American adults have loaned money to their children (https://www.bankrate.com/finance/credit-cards/lending-money-survey-2019/). Sadly, many reported the assistance to their child as having a negative impact, causing them to lose money, and even hurting their relationship.
In discussing this issue with clients, we often have people tell us that they do not see a need for formalizing these transactions. Instead, most families opt to “handle it with a handshake.” While that thought is understandable, it evidences a misunderstanding of the value of a written agreement. Formalized loan documents are about much more than making the loan legally binding.
Here are just some of the benefits to families who put basic legal instruments in place for their family loans:
- Clarity between the parties. “Pay me whenever it works for you” usually results in payments not being made. Too many times, the family loan is the easiest bill to ignore and the last one to be paid (if ever). This can lead to hard feelings and problems in the relationship. A written instrument makes sure that everyone has an understanding of the payment terms and both sides have agreed to be accountable to the plan. Now the payment is a priority.
- Clarity for the lender’s other children. One of the most common family problems we see in these situations is the impact the loan has on the relationship between the borrower and the other children who did not borrow money. This is especially true when the parent has passed away. Children are left to argue over how much was owed, when it should be paid back, etc. Many siblings have ended up with broken relationships over this issue. Simple legal documents and a payment ledger can bring transparency to the transaction so that everyone knows exactly how it is to be handled after you are gone. (This is especially important in Ohio where payments to family members are presumed to be gifts, unless proven otherwise by facts of the transaction.)
- Security for the debt. It is usually true that the child who needs to borrow money has some other financial issues. Many parents lend the money with the thought that it will fix the issues and be paid back soon. Unfortunately, we often see the child continue to wrestle with other creditors. If those creditors eventually collect against the child’s assets, there may be nothing left to pay the parent. A simple property mortgage, title lien, or other security instrument can ensure that the lending parent is in front of the third-party creditors. This ensures that the parent is paid and never ends up losing out to some company’s collection efforts. A security interest in an asset also gives the parent a convenient way to get paid later. Maybe the child cannot make payments, but the payoff will happen automatically when the child goes to sell their house or car.
- Protection for the parent in the event of a divorce. Many people lend money to their married child with the understanding that the couple will be paying it back. If undocumented, that loan is often forgotten and ignored in a divorce action. Legally-binding instruments ensure that the divorce court must deal with it as part of that case and make sure that someone is responsible for its payment (or that it is paid out of the sale of an asset).
- Protection of the parent in the event something happens to their child. If your child owes you money and dies, you may have a hard time proving and collecting that handshake debt. If you have legal documentation of your loan, you simply file a claim with the probate court and receive your funds out of their estate administration.
These are just some of the benefits to memorializing your family loan in simple legal documents. It doesn’t have to be complex or expensive. A simple discussion with your attorney and a few pages of paper can make a world of difference to your ability to be repaid and keeping peace within your family.
We have seen many families torn apart by these transactions and the misunderstandings that too often accompany them. We strongly encourage you to have an attorney provide basic documentation to ensure your loan never becomes a problem for you or your family. You will be happy you did.