Field Notes Blog > Private Lending Best Practices
Private Lending Best Practices
March 12, 2018
Featured Guest Writer: Dan Brogdon, AgChoice executive loan officer
In many communities, borrowing money from friends and family is a common practice. These intergenerational loans can be a win-win situation for both borrower and lender. Private loans can include lower interest rates and liberal terms, when compared to commercial lending institutions. For many young people, private loans also can help begin their farming careers before transitioning to a commercial lender.
No matter what the funding source, borrowing and lending money has inherent risks. When considering a private loan, these best practices can help protect both parties from potential problems.
Ask questions. Typically, private lending funds are available immediately. As you discuss the transaction, ask questions to establish the loan terms. Is this an interest only loan? What are the repayment terms? Is this a five-year loan or a 20-year loan? Fixed or variable term? What happens if the lender needs the money returned sooner than the term? Be sure both parties understand and agree to terms that will not leave you cash strapped in the future.
Interest rates fluctuate. If you make a private loan at a fixed rate, understand that you may miss a market opportunity when interest rates climb or decline.
Balance sheet basics. Private loans to your family members remain a loan. Borrowers should record any loans, regardless if from private sources or a commercial lender, on your balance sheet. Disclose all debt on your balance sheet.
Financial risk. Typically, a private loan does not include collateral. If a friend or family member runs into financial trouble, it exposes you to a loss. If a borrower defaults on a loan, you are an unsecured creditor without collateral. Are you prepared for a financial loss?
Consult an attorney. Before lending money, ask your attorney to draw up a promissory note outlining loan agreement terms. Financial agreements should always be in writing to protect both the borrower and the lender.
Consult a tax professional. Be aware of any tax reporting requirements, including IRS Form 1099. The IRS also dictates minimum allowable interest rates. Learn more about seller financing requirements from a tax professional and the winter 2018 Hitching Post newsletter.
To learn more about private lending or associated tax implications, please contact your local AgChoice loan or accounting officer teams at 1-800-998.5557.