As moms, we must be meticulous with our finances to ensure that we have enough money to support our households. Especially now in Detroit, as we continue to recover from the economic challenges of the past two years. The city’s unemployment rate remains unstable as it still fluctuates despite recovering from a 40% rate in mid-2020. And while job growth was predicted to increase this year, it is projected to slow down in 2023. With economic conditions like these, it may be difficult to fund big investments.
When this happens, you can forego typical lending fees with intrafamily loans. Sound Dollar states that intrafamily loans are an IRS-sanctioned way to borrow from or lend money to family members. Because these loans often have lower interest rates and greater flexibility, they can benefit lenders and borrowers.
Here’s everything you need to know about them.
For parents, staying liquid is crucial so that any unexpected expenses can be met easily. Our article ‘How to Set Goals to Improve Your Finances’ lists some habits you can practice, like setting up a monthly budget, consulting a financial advisor, and keeping a detailed record of your expenses. However, there are times when you may need to make investments that cost more than your cash flow can handle. Intrafamily loans help families achieve this since they are much easier to secure, even without a good credit score. With lower interest rates and greater flexibility when it comes to repayment terms, the conditions of intrafamily loans can be more favorable than those of traditional financial institutions. Moreover, you skip administrative costs, appraisal fees, and closing costs. Lenders can also benefit from these loans since they can earn their money back at a greater interest. You usually make around 0.10% interest when you put your money in a savings account at a bank, but intrafamily loans allow you to earn more than 3% in interest.
Risks and downsides
One of the upsides of an intrafamily loan is not needing a high credit score to secure a good deal. However, even if you make your payments diligently, they may not affect your credit score. This may be a drawback since a good credit score gets you better deals on loans, rewards, and insurance terms. For moms, an intrafamily loan may be a missed opportunity to secure these benefits for their families. Another common concern with intrafamily loans is the financial risk they pose. If borrowers fail to make their payments, the lender would either have to sue or absorb the loss, which can lead to difficulties in familial relationships. To avoid these complications, you should put everything down in writing, as stated below.
Writing everything down on paper helps avoid any tax or interpersonal repercussions in the long run. A promissory note is a contract that signifies the borrower’s intent to pay back their loan and must include your loan terms. You must agree on a repayment schedule, whether monthly, quarterly, or yearly. You must also settle on an interest rate, which leads to the next section.
Taxes and interest rates
Complications may arise when agreeing on a loan without interest. Lenders may have to pay taxes for imputed interest — or the interest rate the IRS estimates the lender should have charged. For moms who don’t want to be faced with unbudgeted expenses, it’s best to avoid such complications. To do so, you will need an interest rate equal to or higher than the Applicable Federal Rate (AFR). AFRs are the minimum interest rate for private loans the IRS allows. It varies depending on the term of the loan — short-term (less than three years), mid-term (up to nine years), or long-term (more than nine years). Lenders will also have to pay taxes on the interest they’ve earned from the borrower.
Intrafamily loans can be an excellent option to explore when making significant investments. By knowing its risks and rewards, moms like you can make the best financial decisions for your family, no matter the economic conditions here in Detroit.