Lending money to family members may seem like a quick solution to help them get access to money, but it isn’t always without complications. If things don’t work out, your relationship may suffer so it’s important to find out what you can do to ensure the arrangement works out for all parties involved.
Many people will turn to a loved one in times of financial difficulty to borrow money. In fact, the Financial Conduct Authority (FCA) estimated that 5.9 million people borrowed money from family or friends at the beginning of the COVID-19 pandemic in 2020.
But an agreement may not always work out - so to avoid a relationship turning sour, it’s important to take precautions and consider different situations before agreeing to loan to a family member.
Lending money to a family member can provide them with funds in an emergency situation and avoid them having to apply for alternative loans such as a payday loan or home credit.
These loans typically have high interest rates so it may seem like a good idea to help them out; however, there are a few things to consider to ensure that all parties are covered.
But before you consider lending money to a family member, make sure you can afford it. You need to have enough money available as a buffer while you wait for the loan to be repaid. Also, consider that there might be issues with repayments and that you need to be financially comfortable if this happens.
There may of course be ramifications if you don’t agree to help them, so weigh up the pros and cons of each decision and choose the option that works best for you.
If the person you are lending money to can’t repay the loan, it may hurt your relationship. Determine if this is worth the risk to you - since it could very well end your relationship.
Here are a few important aspects to keep in mind:
Consider the risk. Work out a payment agreement with the person and make sure you are both comfortable with the terms.
Put it in writing. Get an agreement in writing, clearly spelling out how much they will repay you, and when. A formal agreement can help protect you. It is hard to think about, but if the person who owes you dies, you’ll have to claim from his or her estate and you’ll need proof.
Work with a professional. If a large sum of money is involved, it’s worth getting professional advice or help from an accountant or solicitor to make the agreement more formal.
Collateral or security. It may be a good idea to obtain collateral for the loan. This means taking something from the borrower that you can keep and sell if they default on payments.
There are benefits on both sides, but also risks. It is normal to want to help out a family member in need, as long as you do it the right way - to protect both parties and the relationship.
On the plus side, borrowing from a family member is flexible, easy, and a cheaper alternative than approaching a bank or a payday lender. It saves you from high interest rates and won’t have an impact on your credit score. It’s also a good way of borrowing when you have a poor credit history.
On the other hand, if you are the one lending out the money, it may lead to a sour relationship, or even damage existing relationships with other family members. Also carefully consider whether you can afford it, especially if it’s a large sum of money for a large purchase.
Another downside is that you won’t be able to improve your credit score when borrowing from family or friends. If you are looking to improve your credit you may need to look at alternative options.
Another aspect to consider is inheritance tax when gifting money to family members. From a tax perspective, you should make the loan payable on demand, so that the value of your estate is exactly the same from the time you made the loan, to the time it is repaid.
This prevents the loan from being seen as a ‘transfer of value’ which may then be subject to inheritance tax. Also keep in mind that if the loan is outstanding for a long period, and you decide to waive it, it becomes a gift, which will fall out of the estate of the lender after seven years.
Should you die while the loan is still outstanding to you, the amount will be seen as a deductible liability.
One of the best ways to make sure that you maintain a good relationship is by ensuring you do things the right way - especially when it comes to money. This means putting an agreement in place, discussing loan payment options, and how to handle possible defaults.
By keeping accurate records of transactions and knowing what your rights and responsibilities are, you’ll make the entire process easier and avoid unnecessary difficulties.
You can get a loan agreement template online or ask a legal professional for assistance if you’re considering lending a large sum of money. It helps to make the agreement a bit more formal, yet simple enough so that both parties understand their responsibilities.
If you want to change the terms of the agreement make sure it is done in writing and don’t rely on a verbal agreement. This is especially important for large loan amounts.
People who lend money to friends or family often don’t charge interest. However, consider how much you may be missing out on, especially if it’s a large purchase. It’s worth considering charging the same interest that a bank would have charged.
Charging interest will also prevent the person from considering it a gift.
Simple interest payments are typically the best and easiest. As an example, if you loan £4,000 you can charge interest of £200 that can be paid over equal instalments of £420 for 10 months.
Note: If you charge interest it is seen as taxable income and must be declared as such.
Once you have an agreement drawn up, both parties should sign it in the presence of an independent witness. Also, each should keep a copy. The money can now be transferred to the borrower so that there’s a record of the transaction. A bank transfer or cheque is the best option.
Once you transfer the money, the agreement is in effect and it’s important to keep records, especially of when and how much you are paid. Repayment by standing order is always a good idea here.
As it’s a family member, you may feel confident that they will pay you back. But anything can happen and they may default on their loan, so you need to consider what to do if this happens.
Make sure that you discuss this upfront and come to an agreement on what would happen if they can’t repay the loan or lose their job. Getting this in writing beforehand will make it easier to handle.
If they fail to pay, you can take legal action. For amounts less than £5,000 you can first approach the Small Claims Court or Money Claim Online. Larger amounts will require you to seek legal advice.
Lending money to friends or family may seem like a quick and easy way of helping them out, but it isn’t without any complications. If things go wrong you may not only lose money but your relationship may suffer - and that’s often one of the most important aspects.
Make sure that you have an agreement in place and keep accurate records of all transactions.
With proper planning and proper communication, lending money to a family member can be a great way to help them out and also earn interest in the process.