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Family loans are a popular way to help out loved ones. We’ve all heard about the ‘bank of mum and dad’ to helping out with big financial expenses, such as a wedding or buying a house. But a family loan is not without its complications. So, before lending money to family or friends, find out what you can do to try to make the process a success.
When relationships and money are involved, there’s always a chance of conflict and confusion. It’s important that a family loan is done correctly and clear boundaries are set out straight away – nothing causes tension in families more than financial disagreements!
It may seem a formal approach, but it’s common to put in place family loan agreements. They’re incredibly useful as it allows all parties to be completely clear on what to expect. For example, how much can you lend a family member, when and how often it will be paid back, if there will be interest incurred.
Broaching the subject of gifting or loaning money to family is a bit of a difficult topic to begin with. In previous surveys we discovered 56% of those surveyed were embarrassed to ask their family for help. However, with the older generations (over 75s), a huge 58% actually said 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 of a family loan, the first thing you need to consider is can you really afford to lend the money? Think about whether lending money to family 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 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 family loan, can your family member actually afford to pay you back? Consider how much can you lend a family member, whether they’re going to be able to make regular payments to payback the loan to you within the agreed time frame.
Many people think family loan agreements aren’t necessary due to the personal relationship, but that’s precisely the reason why you should have one in place. A signed loan agreement can help reduce the tension that comes with lending money to family 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 timeframe 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. You can download free family loan agreements online from reputable websites like eforms.com.
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 would earn in savings to make sure you don’t lose out. This will also ensure 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 on loans made privately, you’ll need to inform HMRC and fill out a self-assessment as it may be liable as taxable income. Speak to a financial adviser for advice about UK law and any implications for both parties.
There’s also a different tax implications for gifted money. For more information about the UK law inheritance tax on gifting, read our 'easy guide to gifting & inheritance tax'.
When lending to family, there’s always the risk 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 £5,000, 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 on the right way to ask for a family loan, next.
This article is correct at time of publishing and for general information purposes only. We recommend you speak to a professional financial adviser for advice. You can find a financial adviser and further personal finance information at www.unbiased.co.uk.
