Borrowing money nowadays can be hard to access if you’re new to the credit market or have unfavorable marks on your credit report. Rising interest rates have made it difficult to get approved for traditional bank loans, but an alternative form of funding may be more beneficial for building generational wealth.
Intra-family financing, which is commonly referred to as a “family bank,” is a strategy that even billionaires like the Rockefeller family established to preserve wealth and ensure the long-term welfare of their lineage. In many ways a family bank operates as a cash flow system for assisting family members to secure capital by cutting out the middleman, all the while instituting best practices for financial literacy.
What is a Family Bank?
Family banks act as a family-owned entity, therefore, they aren’t regulated, so there are no accounts, depositors, or funds made available to the public.
“A family bank can provide a source of funding to family members or their related entities, which is much more flexible and customized than traditional commercial, regulated bank financing,” wealth management adviser Warmer King Babcock noted in an article on structuring and governing a family bank.
Black Americans are not unfamiliar with merging financial resources. Years of discriminatory lending practices shut them out of applying for mortgage loans and other forms of financing, leaving many communities with no choice but to collectively pull funds together to create community funds to bankroll small businesses or put money down on a home.
A family bank can be an emotional attachment that requires diligence in overseeing, so it’s important to have safeguards and good governance in place. Here are some considerations to keep in mind if you’re planning on spearheading a family banking system for your loved ones.
Establish Clear Guidelines
Starting small, maybe with immediate family members, is a good rule of thumb to keep things less convoluted as you cohesively work together to establish guidelines. Strong family governance will be crucial for the success and longevity of the bank.
Some kind of document that explicitly spells out the terms of the loan is essential, Jay L. Hack, a banking expert who provides legal services to banks and other financial institutions, told Finurah.
“A handshake is a bad idea,” said Hack, a partner at Gallet, Dreyer, and Berkey Law. “You want to document it and be sure what the deal is. If it’s going to be a loan, act like a lender, don’t act like a parent.”
While lending to family members can be done on less stringent terms, the foundation of a family can’t solely be based on an honor system.
Fund Your Family Bank With Whole Life Insurance
A private family bank gives the option of borrowing funds from a whole life insurance policy. For the duration the policy is held, monthly payments accrue and give the policyholder what is known as “cash value.” Cash can be borrowed before or after the policy matures, which makes it an ideal tax-free system to extract funds.
“By investing in a whole life insurance policy, the policyholder builds cash value they can borrow against while building interest on the entire policy,” said Maria Hanson, an insurance and banking expert with Insure Providers, told Finurah.
Promote Economic Empowerment, Not Entitlement
Accountability is needed to ensure responsible financial stewardship from the borrower. Whether it’s your teenager in need of funds to buy a game console, or your sister who’s in need of a loan to put down on a car, it is important for both the lender and borrower to have a mutual understanding of loan terms or any other requirements of the debt they are taking on.
“It takes a committed group of people who see the value of setting up financial security, so mindset and commitment are the determining factors for success, said Hanson.
Being on the same page about financial obligations fosters intellectual capital and understanding that will help the borrower navigate traditional credit lending.
No Free Money
As tempting as it may be to help a family member in need of cash with no strings attached, in order to act as a family bank, there should be an interest rate incorporated in pay-back terms.
“So long as the rate is more than what’s called the applicable federal rate, which is the minimum rate necessary for the loan to not be deemed as a gift,” said Hack.
With Federal Funds Rate nearing 4 percent as the government tries to get inflation under control, you have the discretion to give family members a lower rate on a loan, which can help them save money in the long run.