17th July 2020
If you have the means, lending to friends and family can be a convenient way to help out loved ones. In particular, it’s very common to help them with a big financial expense, such as a wedding or buying a house.
In order to avoid creating family conflict and confusion, it’s important that the loan is done correctly and clear boundaries are set out straight away – nothing causes tension in families more than financial disagreements! Although you may not think it’s needed, family loan agreements are incredibly useful as it allows all parties to be completely clear on what to expect.
Broaching the subject of gifting or loaning money to family is a bit of a difficult topic to begin with. In fact, in a recent survey we carried out on family and finances, we discovered that 56% of over 3000 people surveyed are embarrassed to ask their family for help. However, with the older generations (over 75), a huge 58% actually said that they enjoy helping out their families with money, so there’s no reason to be embarrassed and there’s no need for it to become a taboo topic!
When it comes to the rules on gifting money to family, the first thing you need to consider is can you really afford to lend the money? Think about whether lending the money means you’ll have enough for potential expenditures in the future. If it’s currently in savings you’ll also need to bear in mind that this can affect the interest you make. Before making this big decision, we always recommend speaking to a financial advisor to help you consider all possible ramifications.
Additionally, if you’re lending the money as a loan, can your family member actually afford to pay you back? Also consider whether they’re going to be able to make regular payments over a period of time too.
Many people think family loan agreements aren’t necessary due to the personal relationship, but that’s actually precisely the reason why you should have one in place. A signed loan agreement can help reduce the tension that comes with lending money and will lay out the terms and a clear payment plan, helping to avoid the awkwardness of having to ask for the money back or resolve disputes later down the line
The family loan agreement should include details such as a time frame for when the sum is expected to be paid back by, any interest (if applicable) and any consequences for missed payments – you may choose to set a fixed penalty or an interest charge for example. Consider things like collateral – if your friend or family member has anything of worth, this can be a good way to ensure your money will be returned to you.
If your money was in savings prior to the loan, it may be a good idea to charge at least as much interest as it’d earn in savings to make sure that you don’t lose out. This will also ensure that the loan is seen as a loan and not a gift.
Be sure to sign the family loan agreement and keep a copy for yourself and once you pay the money, make sure it’s traceable to avoid any disputes – never pay in cash. After the repayments start, ensure you keep record of all payments.
It’s a common belief that because family loans are a personal arrangement, there won’t be any tax implications involved. However, if there’s interest involved, you’ll need to inform HMRC and fill out a self-assessment as it may be liable as taxable income. For loans without interest, you won’t need to tell HMRC. Speak to a financial adviser for advice on this and any implications for both parties.
If the money is gifted instead of loaned, the sum will be free from inheritance tax up to £325,000, but this will only apply if the loaner is alive up to seven years after initial payment. Up to £3000 a year can be gifted without paying tax at all and up to £5000 can be given as a wedding gift. For more information about inheritance tax on gifting, read our guide.
When lending to family, there’s always the risk that they won’t pay you back. If this happens, the first step you should take is to talk to them and find out what the situation is. It may be due to personal circumstances that have changed or reasons outside of their immediate control.
Once you’ve spoken to them, there are a number of steps you can take. If it’s due to lack of funds, you can simply adjust the payment schedule or lengthen the loan period. On the other hand, if your friend or family member is being difficult and there’s a family loan agreement in place, you can seek legal action. For sums below £5000, you may wish to take the issue to small claims court and for larger amounts it’s always best to seek legal advice to find out how best to proceed.
Now you know the basic rules on gifting money to family and why it’s best to set up family loan agreements. If you’re not sure where to start with the conversation on giving or receiving a financial gift, read our article for our top tips and advice, next.