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How to navigate lending money to family and loan agreements
If you have a family member who is struggling financially, or simply can’t seem to catch a break, you might want to give them some support. And you might want to give this support in the form of a loan.
This is a lovely notion – and eminently doable. However, it’s also one that needs to be considered carefully. We’ve all heard the sour stories about family loans where the borrower never repays the loan, or the relationship becomes strained or broken.
But if you go about it the right way, understand what could happen, and get some good legal advice and paperwork sorted via a loan agreement between family members, you can certainly help out your family member with a family loan.
Considering lending money to family? Here’s what you need to know.
The first thing to ask yourself before making a loan to a family member is if you should.
Should you loan money to family?
While you can always lend money to family members, that doesn’t mean you necessarily should. It’s important to first understand how any loan could impact you financially before you make any decisions.
Ask yourself – what financial position will you be in if you enter the loan. If it will put you into financial strife or make it difficult for you to pay your bills, keep up with your lifestyle or support your immediate family (such as children), you should not make the loan.
You should also think about the potential borrower. Are they a good financial bet? Do they have a history of paying back their bills generally? Or are they financially irresponsible? The answers to these questions will help you know whether the loan is a good idea, or not.
The simple rules for lending money to family
If you do decide to go ahead with the loan, there are seven rules and guidelines to ensure you stick to, to avoid any pitfalls.
1. Always have an executed loan agreement between family members
The first and most important golden rule for lending money to family is to have an executed loan agreement. This ensures that your loan will be treated as a loan, sets up any security you might need, lays out the terms of the loan, including interest rates and repayment timing, and ensures that both parties understand their legal rights and responsibilities.
2. Only lend money you’re not afraid to lose
Whenever you make a loan, you’re taking a risk that you could lose that money. If you’re worried that you’re not in a strong financial position to make the loan, or you aren’t willing to lose the money generally, then you should just say no.
3. Get expert tax advice
There are tax implications for any loan, including loans between family members. While the ATO says that generally small loans from family members aren’t considered taxable income, more substantial amounts could be. It’s best to get expert tax advice from your tax advisor before you enter into any loan.
4. Understand the implications of large loans versus small
Large loans of significant sums may be treated differently than small loans when it comes to making a loan to family members. Speak to your financial and tax advisors to understand these implications and to make the best choices when it comes to how much to lend.
5. Understand the purpose of the loan
It’s a good idea to understand the purpose of the loan – in other words, what the loan monies will be used for. If you’re lending money to family to buy a house, for example, it’s important that this be documented in a way that ensures the property is security for the loan. If not, you may be at risk of coming last in the line of creditors if a financial disaster strikes.
6. Be clear that your loan is not a gift.
When you make a loan to a family member, you want to ensure that your loan documentation sets it out as a loan. If not, you could be at risk of having it considered a gift. A gift is money that is given but that you don’t intend the recipient to repay. But a loan contemplates repayment according to the loan terms.
It’s important that you have this very clear, both from a financial perspective and for clarity between you and your borrower, so that you get your repayments on time.
7. Make sure it’s an arms-length transaction
Treat your loan arrangement as a business deal. That means that it’s an arms-length transaction whose terms would be fair for anyone. Set out your repayment timeframe, repayment dates and amounts, interest rates and more, just as you would with any other borrower.
How to say no to lending money to family
Sometimes you may find that the loan isn’t in your best interests. In that case, you’ll want to know how to say no to lending money to family. Of course, it’s not always easy to say no to a family member. So here are our top suggestions to help.
1. Be straightforward.
When you say no, be straightforward and clear. Don’t equivocate or try to soften the blow. This could lead to your loved one feeling led on or to continue to hold out hope. Just say no, simply and clearly, so that everyone has clarity and there’s no confusion.
2. Gently explain.
Your family member might feel a bit hurt or confused. So you may want to gently explain your reasons for saying no. This might be because you aren’t in a financial position to make the loan, because it might negatively impact your immediate family, or because you have a policy of not making loans to friends or family.
3. Find another way to help.
This might include offering to help them sort out their finances, set up a budget, find ways to save money on their expenses, earn extra money on the side, or even help them out with groceries a few times. Offering to help another way can give them a boost while keeping you comfortable in your own financial situation.
Legal implications for lending money to a family member
Lending money to a family member comes with its own set of legal implications.
1. Wills
When you are making loans to family members, it is always important to consider how that loan should be dealt with upon the death of the lender.
It could be that the loan is to be forgiven, or is to be repaid, or is to be taken into account as an asset of that family member if that member is also a beneficiary. This should be discussed with your lawyer.
2. Verbal agreements are risky
While a verbal agreement is legally binding, it is practically difficult to prove or enforce. Because of that, you should always take formalise your loan arrangement with a signed and dated loan agreement. If not, you might not be protected if something goes wrong, and you might not be able to prove the terms of your agreement if you need to in court.
3. Any loan for an asset should have the asset as security
If you’re giving your family member a loan to purchase a home, property, or another substantial asset, you need to ensure that the asset is used as security for the loan. This doesn’t just make financial sense. It also ensures your place in priority in the case of bankruptcy or failure to meet the terms of the loan.
Without the security, you’re at the end of the list of creditors, and you may never get your money back. With security, you can be at the front of the queue, and your money is better protected.
4. Legal document for lending money to family
If you’re entering into a loan with a family member, you need a signed and dated loan agreement.
Most of us want to be able to help our struggling family members
When done right, lending money to family can be a great thing for you and your loved ones.
Our team is on hand to ensure that you consider all the legal implications, get the right expert advice, and set up the formal documentation for a loan agreement between family members. And that means you can get a beneficial arrangement in place and be confident in your family loan.
