It has always been common to lend small amounts of money to friends and family members on an informal basis. Few people bother with a written legal agreement, and even fewer ask for interest to be paid on the loan. Increasing numbers of people are starting to take larger loans from friends and family members.

The main reasons for this are high house prices, rising interest rates and a difficult mortgage market, borrower credit history, student debts and tuition fees. For example, many families are offering loans to help their offspring get a foot on the housing ladder and clear their student debts a bit quicker and friends are helping their friends to purchase investment properties.

These loans have pitfalls for the unwary, so it is critical that you take expert advice, so you are aware of the implications before committing to any loan. 

Key factors you need to consider:

Affordability

Ask yourself whether you can afford to make the loan. Consider possible changes in your circumstances – would lending the money leave you enough of a buffer? Think carefully about the consequences to your personal relationship with the borrower. 

Consider whether the borrower can afford the loan. Will they be able to repay it within a timeframe that you are happy with? Sometimes in these situations, the 'borrower' is really looking for a gift and has no real intention of repaying the money. This may not even be a conscious decision on their part but it is essential to be clear on this. You might decide that you want to make a gift (perhaps of a smaller amount) to avoid bad feelings and potential complications associated with a loan – but both parties should be aware of the decision to make a gift and why.

Legal implications

It is possible that your loan may be regulated by the consumer credit rules of the Financial Conduct Authority (FCA). If it falls under the FCA regulations, there is a risk that any loan agreement may be unenforceable. A number of exemptions are available but these should be checked. 

A written loan agreement should be considered because, by setting out your conditions in writing, both you and the borrower can agree the terms and the repayment with full awareness. For example, a written loan agreement trumps any misunderstanding of the borrower that a gift was intended in the event of a repayment issue. 

Security

It may be decided to secure the loan if there is a risk of non-payment. If the security is over land, tread very carefully and take advice as it is possible that your loan could be subject to separate FCA rules on regulated mortgage contracts.

Interest

Very few family loans charge interest but it is more common for loans between friends. You should consider whether you will lose earnings on the money so it could be a good idea to charge at least the same interest that you would earn on the money if it stayed in your possession. Charging interest will also discourage the borrower from viewing the loan as a gift. Remember that if you do charge interest it is taxable income in the eyes of HMRC.

Enforcement

If the borrower does not repay in accordance with the terms of the agreement, it is your choice as to how to proceed. The first step is to talk to them – establish what the problem is and whether it can be resolved. You may wish to vary the terms in the initial agreement (to give them more time to repay, for example). If the agreement has been breached and you want to take legal action to get your money back you will need to seek legal advice.

If you would like help setting up a loan for a friend or family member, get in touch with our specialist commercial lawyer, Simon Porter, who has a wealth of experience in this area of financing. Call 0330 0945 500, email info@nevesllp.co.uk or complete our contact form and we'll get back to you.