Intrafamily Loans: Should You Borrow From Family Members to Go to School?
Paying for college is much harder than it used to be. Add growing tuition to the challenge of finding a job with a decent wage in today’s economy, and prospects are bleak for many college students.
While the federal government offers low-interest loans—and grants, for those who qualify—to students with the most financial need, that money frequently doesn’t cover the whole tuition bill. And many students and families who don’t qualify for the best subsidized federal loans still can’t afford to pay for college out of their own pockets.
Because of this, many students take out private loans with high interest rates—often as high as 16% or more—to cover the gap. Over $150 billion is given out each year in private student aid.
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Of course, paying off a private student loan can be difficult. According to a report by the US Education Department* and the Consumer Protection Bureau**, defaults on private student loans
rose to as much as $8 billion in the past decade.
Paying for college isn’t easy, whether you’re attending traditional school or an accredited online degree program—even with family members ready and willing to help.
Borrowing from friends and family can be tricky. If everything doesn’t go as planned and the borrower has difficulty paying back the loan, they may expect leniency and the lender may feel obligated to be lenient under the rules of friendship and love. But with a lot of money at stake, sometimes they can’t afford to be.
There are ways to get around this potential dilemma, however. Intrafamily loans provide a legal structure and framework for lending large sums of money among family members and other loved ones.
The IRS regulates larger intrafamily loans, requiring the borrower to pay interest. But the interest must conform to the Applicable Federal Rate*, a rate the Fed suggests for income tax purposes. It changes monthly, but the rates are low—often lower than the interest rates on federal student loans. Loans in amounts smaller than $5,000 per academic year or $10,000 in total can be issued without interest. Contributing to a larger fund does not typically result in a tax deduction.
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Typically, a lawyer draws up a contract for the loan. The family establishes ground rules, such as repayment schedules, interest rates, penalties for nonpayment, and contingency plans for life events that could affect repayment, such as losing a job or a sudden illness. These plans can be a good deal for the lender as well as the borrower, as the interest rates they earn back from the loan could be more than they’d earn in a typical savings or money market account. And entire funds can be set up, with multiple family members contributing.
However, intrafamily loans are not for everyone. Even firmly established repayment guidelines and terms can’t stop rifts from occurring if a borrower can’t or won’t repay a loan. Some families simply don’t have the cash to assist in this way—and doing so can compromise retirement, particularly if the borrower fails to pay back the entire loan.
Paying for college isn’t easy, whether you’re attending traditional school or an accredited online degree program—even with family members ready and willing to help. To minimize risk when borrowing from family, it helps to have a firmly established legal contract with clear terms.
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