The essential guide to loaning money to family or friends
Should you lend money to family or friends?
Many people do not like the idea of mixing money lending with personal relationships. However, while it is true that loaning money to family or friends can cause tensions within relationships - particularly if the borrower does not pay the money back as agreed - private loans between family and friends can be a more flexible and cheaper alternative to using a bank or payday lender.
Loaning money to family or friends who do not have a particularly good credit history, or young people who do not have a credit history at all, can be the only way for them to get the cash they need.
Will lending money to family or friends damage our relationship?
When money is involved, there is always the potential for tempers to fray. In order to minimise the risk involved in lending money to family or friends, it is crucial to make sure you enter into a legally binding written agreement detailing the loan and its repayment terms.
Loaning money to family or friends: affordability is key
You need to ensure both that you can afford to lend the money and that the borrower can afford to pay it back.
If you are at all unsure about either of these factors, it is important to carefully weigh up whether lending money to this person would be the right thing to do.
Also, consider how lending money would affect your relationship with the person, as well as wider family relations. What would happen if they did not pay the money back? If they are one of your children, would the other children want to be treated equally and have the offer of the same loan?
Ultimately, it is your decision whether or not you agree to a loan. While refusing a loan can cause arguments in the short term, it is likely to cause less problems that loaning money when you feel uncomfortable about the borrower’s ability to repay.
Should you charge interest on loans for friends and family?
This is an entirely personal decision. You may decide that you are lending the money simply to help the borrower and do not require any interest in return. Alternatively, you may charge interest to reflect the fact that the money is not earning you money in a savings account or shares.
Charging interest can help to ensure that the borrower does not see the money as a gift.
It is important to note here that if you do charge interest on a private loan, this will be seen as taxable income and must be declared to HMRC.
Make sure to use a written loan agreement when loaning family or friends money
It can seem too formal to enter into a legal agreement with someone close to you but a written loan agreement is a good way to ensure that both parties know exactly what the loan entails. In fact, having a loan agreement in place may actually reduce the chance of tensions rising and arguments breaking out due to a lack of clarity about the loan’s terms.
If the borrower seems unwilling to enter into a loan agreement, this could be a ‘red flag’ that they do not want to pay the loan back on your terms - or at all.
What is a loan agreement?
A loan agreement between family and friends is a legal and binding contract which sets out the terms of the loan. It will include the interest rate (if you intend to charge interest), the loan amount and the repayment terms, including the dates and amounts of the repayments.
What is an unsecured loan agreement?
An unsecured loan agreement is used when the loan is not backed by any collateral. This means that the lender has no entitlement to the borrower’s assets if the borrower does not repay the loan. It is also known as a personal loan.
Where can I find a loan agreement for family or friends?
You could ask a solicitor to write up a loan agreement for you. Alternatively, you can download a loan agreement for family or friends template right here at LegalPath.
Make sure your keep a record of your loan agreement
Both you and the borrower should have a copy of the signed loan agreement.
When you transfer the borrower the money (once the agreement is signed), make sure there is a record of you handing over the money. For example, you could transfer the money from your bank or give the borrower a cheque.
The borrower should also keep a record of their repayments in order to avoid any future disputes over missed payments or the amount of the loan left to repay.
What happens if the borrower does not pay back the loan?
It is up to you what action you take. Normally, it is a good idea to talk to the borrower and find out why they have not repaid the money as agreed. This way, you can try to resolve the problem before taking any legal action.
Any variation of the terms of the loan should be written into an updated loan agreement.
If you cannot resolve the problem between yourselves, you can take legal action. If the loan’s value is less than £5,000, it will be necessary to go to the Small Claims Court.
If a larger amount is involved, you would need to obtain legal advice from a solicitor.
READ MORE: Lending money to family or friends? How to make sure you get your money back