Real Estate Tips |7 min read

Family Loan: 7 Cons of Borrowing Money from Family & Friends

If you’re considering a family loan to renovate or help buy a property, there are many reasons you might want to stop. Borrowing from family and friends can have disastrous consequences. Get informed on what they are before you make a grave mistake, both in your real estate career and out.

Main Takeaways

  • A family loan can drive a wedge between you and your loved ones because it blurs the boundaries between your personal and professional life.
  • With informal loans, you don’t have the same legal protections or credit-building opportunities as you would an official one.
  • Your loved one could have to foot the bill on taxes if you lent from them.

Table of Contents

  1. The Family Loan Can Erode Your Relationship
  2. It Can Give Your Loved One Too Much Power Over You
  3. The Request Can Place Undue Financial Hardship on Your Loved One
  4. You Have Fewer Legal Protections
  5. Your Arrangement Could Cause Rumors to Spread
  6. Taxes Become More Complicated
  7. You Can’t Build Credit with Informal Loans

1. The Family Loan Can Erode Your Relationship

By borrowing money from family and friends to spend on properties, you mix the personal with the professional and financial. As a result, the boundaries in your relationship will inevitably blur. That’s why a family loan is a recipe for disaster. Our Baltimore fix-and-flip loan providers have seen how its effects reverberate into both sides of your life.

First of all, a family loan could tangle the relationship into a vague, yet all-pervasive awkward atmosphere. It could become the elephant in the room, the negative space that fills up a conversation.

After all, friendship is built on one sacred tenet. Namely, that you care about the other person first and foremost, and that the bond between you is what matters most. However, business interests prioritize your money above all else, by nature. These interests are fundamentally incompatible.

Due to this value clash, there’s no way to get around it – bringing money into the equation can threaten the foundation of your relationship.

For example, when family or friends even just ask for repayments, it shows a shift in their priorities. It shows a self-centered focus on their own financial stake, not pure concern for the other person’s financial well-being.

Furthermore, even though your ability to repay is solely a financial problem, the other party could take it personally. After all, since they’re doing you a huge favor, the right thing to do as a friend is to bend over backward to repay that favor. A family loan is a promise, and you’re expected to keep it.

Keeping this promise shows how seriously you take their sacrifice for you. As such, if you can’t meet those expectations because of external factors, they may misinterpret the issue as a lack of effort.

2. It Can Give Your Loved One Too Much Power Over You

On the worse end of the spectrum, a family loan could alter your relationship’s power dynamic. After all, money changes and corrupts people.

The person could lord their power over you throughout your exchanges. Since they’re in a more advantageous financial position than you are, that sense of having an upper hand could extend into your other interactions. This could translate to a subtle sense of superiority on their part.

For instance, they could show this through subtle comments and assumptions. Or, they could showcase implied or outright blatant entitlement to your time and energy because they have shelled out money for you.

Because they have an investment in you now, they could also scrutinize and judge your financial actions more closely than they would otherwise. If you make purchases, they deem frivolous, it could drive a wedge between you. In some ways, your life isn’t just yours to live anymore.

Such attitudes could continue far after you pay the family loan back. After all, money is an incomparable resource. There is little you can do, besides somehow drawing up something of equal value, that can truly balance the scales between you again.

3. The Request Can Place Undue Financial Hardship on Your Loved One

Furthermore, on a moral level, you must think about whether you’re unintentionally pressuring the person into doing something they aren’t truly comfortable with.

By this, we mean that the person might feel obligated to give you money because a friend has to be supportive. If they didn’t agree, it could inadvertently imply they don’t care enough. So, they might feel like they have no choice but to give you money, even if they don’t have much to scrape together themselves. It puts them in a very compromising position.

All in all, borrowing from family and friends can be an emotional liability. It can be the ball and chain that bogs down your relationship.

4. You Have Fewer Legal Protections

If you don’t make the terms of your family loan legally airtight, the other party will fill in the blanks with their own assumptions of the rules.

For example, they could have their own ideas of when you’ll pay them back. In addition, they might take their loan to represent more than what it really is. Even worse, they could consider their contribution to be their stake in your real estate business.

All these vague areas invite conflict when borrowing from family and friends. These arguments could boil over in court. An official commercial real estate loan wouldn’t give you this problem.

5. Your Arrangement Could Cause Rumors to Spread

To boot, you can’t ever be 100% sure that your friend or family member will stay completely mum about your financial straits. After all, you can’t control other people’s behavior. For example, if someone is on really hard times, no they wouldn’t want strangers to know they’re trying to do house flipping with no money or buying a rental property with few funds. It’s just not possible to guarantee your finances will stay private when a friend is involved.

6. Taxes Become More Complicated

According to the IRS, when someone gives another person unreciprocated money, that counts as a gift. Gifts over $18,000 require interest as of 2024.

If you do plan on paying the family loan back, your makeshift lender can ask for interest. When that happens, they will pay interest on your interest because it counts as their income. Furthermore, even if your makeshift lender doesn’t make you pay interest upfront, the IRS could still force them to pay taxes on the interest that should have been there to begin with.

In either case, when borrowing from family and friends, they could pay for their kindness, literally.

Another tax issue is documentation. You could land in hot water with the IRS if you’re exchanging money under the table. Moreover, it would be challenging for an individual to undergo all the officializing procedures a professional lender would. Unlike an official commercial real estate loan process, you can’t ensure you’re staying legally compliant the whole time.

7. You Can’t Build Credit with Informal Loans

Because credit bureaus don’t recognize family loans, you cannot use your successful payment to boost your credit score. As a result, you are letting slip away the chance to qualify for bigger real estate investments in the future.

Get a Commercial Real Estate Loan with MHML

If you’re borrowing from family and friends, you open yourself up to many serious personal and financial risks. You could destroy your friendship. You could face tax-related and legal consequences. Finally, you can’t build credit with family loans. Overall, it’s just not a good idea.

If you want an official commercial real estate loan with legal protections, clear terms, and no drama, we are here to help. Our professional team has years of experience in the industry. We know how to cover our bases so that all parties are covered when it comes to legalities, fees, taxes, and other critical details. Even better, we can offer you seasoned support and advice every step of the way, so your investment goes smoothly.

All these benefits show the difference between borrowing from family and friends and borrowing from actual specialists. Contact us today to make sure you get the most secure, legitimate loan possible.

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