Unmarried Couples Finance: Borrowing/Lending

Over at The Debt Chronicles, Sunflowers describes how she went about borrowing the money to pay off her consumer debt from her Significant Other — and how inferior it’s making her feel despite all her efforts to do right by him. About 5 years ago, I helped my debt-ridden sister (aka Bridezilla) through this exact situation. She and her then-boyfriend came to an agreement, not sure if anything was signed, but I thought it was perfect. I got involved only as the Excel “expert” who could set up a spreadsheet to calculate and track her payments.

Here are a few points to consider, from both legal/tax angles as well as emotional ones…

Tax implications

Feel free to chime in and correct me, because I’m working from a memory of a conversation with my CPA maybe 3 years ago when discussing loans to family. I’m not qualified to give advice on this – but hopefully I can help anyone in this position figure out what questions they should be asking….

• As the recipient of an interest-free loan, there’s a tax implication for that sweet deal, but I don’t remember how it’s classified. Would be great if it could be considered a gift, but I don’t really know.
• If you pay interest on a loan, the lender is supposed to pay tax on that as interest income.
• Since I was dealing with immediate family members and the amount was below the non-taxable gift limit ($12K or $13K these days), my CPA cleverly phrased a suggestion that we define it that way to avoid a lot of annoying nickel-and-diming.
• I think, legally and taxwise, it is viewed quite differently if the person making the loan directly pays the borrower’s credit card companies. Like maybe it doesn’t count towards the maximum tax-free gift limit or something (strangely, I recall this from an episode of Divorce Court, which I used to watch on the personal TVs at the gym for lack of any other 10am viewing options…it was either that or who’s-yer-daddy Maury or Rachel Ray, and I can’t stand her voice).
• If the occasion arises for me to loan money to a Significant Other, I’d draw something up and get it notarized to protect myself…and then hopefully not have to use it. It would be more of a back-up plan.
• In Sunflower’s position, she and M have a joint account. I think that would make it very easy to make repayments in the form of transfers out of the joint account and into his personal one.

The Psychological Backlash

My sister and her then-boyfriend agreed on an interest rate of 5%. That was WAY below the 18-25% she was paying, which would allow her to pay off the debt really fast. For him, it was about the same rate he could get on a CD. I thought this was a great way to handle the financial imbalance in the relationship because it cost him nothing in the short term to improve their long-term situation (had there been one). My sister, however, was unable to see it as fair to him in any way because she was getting all the benefit while he just broke even on the deal. I tried so hard to help her see that it wasn’t costing him a penny to help her like this, but she had been under the burden of about $20K consumer debt for so long that she couldn’t overcome her “loser” feelings. FYI, this was not the underlying reason why their relationship didn’t work out.

Currently, she has an outstanding car loan with me, at an agreed-upon interest rate of 6%. She’s had the loan for 3 years and only paid 15% of it back in the beginning and nothing since, and she feels really bad about it. Two years ago, I told her that I considered it an investment in my old age, because without a car, she wouldn’t have been able to go to nursing school. I’m not going to have any kids to look after me when I’m old, so it will be extremely advantageous to have a sister wired into the medical community – and used to changing old lady diapers. I recently informed her that she doesn’t start accumulating interest until June, giving her an additional 6 months’ grace period after graduating. Like a student loan, which it really was in a sense. I made her okay with this by pointing out that I would have had all that money in the market and lost at least half of it in the last few months. I actually thanked her for saving a significant chunk of my savings from the Diving Dow — that really got through to her.

Conclusions

• As a lender to family members, I swear to you I’m perfectly happy getting interest equal to market value.
• As a borrower, ALWAYS offer – or even insist on! – interest because it’s proof that you’ve thought through your need for a loan, understand the impact on the lender, and truly care about fairness.

Anything I’ve missed?
Anything I got ass-backwards?
Any caveats of your own to throw in?
Please let me know with a Comment!