Interest rate when lending personal loans
We get a lot of questions about whether it’s a good idea to charge interest on a personal loan. Interest can be an important loan term that you can set when lending personal loans to someone you know, like friends or family members. Otherwise, you may get stuck with the tax implications. So, let’s find out how much is considered a fair amount of interest.
Is it Necessary to Add Interest to a Friend and a Family Loan?
No, it is not necessary to charge an interest on a personal loan. However, if you want to charge any interest, you are free to do so. It is important to note that the interest charged can be subject to income tax. Not doing so may result in tax penalties that can become costly.
What are the Tax Implications When Lending Personal Loans?
As mentioned above, your taxes can get all fudged up if you don’t charge interest when lending to friends or family. The IRS may consider it as a gift if you are not able to prove that the borrower paid you back. It will tax you when you receive the interest on the loan as income.
If you don’t charge an interest rate, but you proved that the borrower repaid the loan, the IRS will tax you based on that income. So, by charging interest, you can protect yourself from losing money.
How Much Interest is Right When Lending to Family or Friends?
Although there is no minimum and maximum interest rate that you can charge on personal loans, below are some details to help you determine a good interest rate for lending money:
- The minimum interest rate on a personal loan is known as the Applicable Federal Rate (AFR). It updates monthly based on economic factors. For instance, the AFR in April 2022 was 1.26% for short-term loans, 1.87% for mid-term loans, and 2.25% for long-term loans.
- The maximum annual percentage rate varies depending on the location or state. For instance, it is 40% in Nevada and 18% in Vermont.
What Else?
Studies show that lending out loans at 5% to 10% APR is not a big deal if you can manage the financial obligation. You can set an interest rate that is above the federal minimum and below your state’s maximum. Charging the right amount of interest when lending to family or friends will keep you from losing money on the loan and safeguard personal relationships. That is a personal finance tip every lender should follow.
Hope you are clear enough now!
Summary: When people around you need financial help, it is great to lend money. But should you charge interest on these loans? If yes, how much is fair when lending personal loans? Let’s find out!
Description: Lending money helps the people around you, but you should also charge some interest to safeguard your finances. Read on to learn how much interest is fair when lending personal loans.