Should you lend to friends and family

Looking for an agreement?

If you have reached this page looking for an agreement, and not information on them, you can find the documents discussed in this article at the end of the article.

Should you mix friends or family and finances?

Private loans between family members and friends are a convenient, flexible and cheap alternative to using loan organisations. Many people in need of a loan will first approach relatives or friends who appear to have money to spare, especially if the borrower does not have a good credit history, or is just starting out financially. The lender may have good reasons for making the loan which are not financial, for example parents lending their children money for university or to help them buy their first home.

Consequences of loaning

Whatever the motivations are for such private loans it is important to be aware of the potential ramifications of introducing financial matters into a relationship. For example, the lender might appear to gain power over the borrower, or siblings who have not received similar loans could become jealous of those who have. Even worse, what if the borrower can't or won't pay back the loan? To avoid such damaging implications (to relationships or finances) it's a good idea to first consider carefully whether to make the loan, and then formalise the terms of the loan and repayment arrangements in a loan agreement.

Can you afford it?

First ask yourself whether you can afford 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. Of course there are implications to denying the loan as well, but at the end of the day it is your money and your decision. If you have real fears about the possible consequences of the loan these will outweigh the (usually temporary) bad feelings resulting from refusing to lend.

Can they afford it?

Next you should think about whether the borrower can afford the loan. Will they be able to repay it within a time-frame 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 loan. This may not even be a conscious decision on their part but it is essential to be clear on this. You might even decide that you want to make a gift (perhaps of a smaller amount) avoid bad feeling and potential complications associated with a loan – but both parties should be aware of the decision to make a gift and why.

Of course, you will want to know why they want the loan, and this could affect your decision to give it. If you can see they need the loan for a good reason but don't trust their ability to manage the money you lend them, why not offer to pay it directly to where it is needed? On the other hand they may be perfectly able to approach a financial institution for the loan but are looking for a cheaper alternative – it's up to you whether you want to oblige.

Using a loan agreement

If, after addressing the above questions you still want to make the loan, you will probably have thought of a number of conditions in the process. Hence it is clear to see why a loan agreement is a good idea. By setting out your conditions for the loan in writing both you and the borrower can agree with full awareness on the terms of the loan and its repayment.

It may seem quite hard-nosed to insist on a loan agreement when dealing with friends or family, but it is the best way to separate your personal relationship from a financial relationship and to acknowledge that personal ties should not influence or be influenced by financial responsibilities. If there is reluctance to use such an agreement then complications exist already!

A loan agreement sets out the terms of the loan, in particular the amount to be loaned, the interest rate, the dates and duration of the loan, the frequency and value of repayments, any collateral used to secure the loan and under what conditions you will be free to sell or take possession of the collateral.

Collateral or security

It may be a good idea to secure the loan by obtaining collateral, that is, taking something from the borrower which you can sell if they fail to repay the loan. Ideally it should be something which would cover the value of the loan, but if there is nothing of sufficient value, choose something of personal value to the borrower which will give them incentive to stick to the terms of the loan. You should include this collateral and what can be done with it in the terms of the loan agreement.

Interest

Most people who lend to family or friends do not charge interest on their loans, however you should consider whether you will lose significant earnings on the money during the loan. It could be a good idea to charge at least the same interest that you would earn on the loan amount if it stayed in your possession. Charging interest will also discourage the borrower from viewing the loan as a gift.

Simple interest calculations are usually the best, and the simplest is a fixed amount over the term of the loan, for example, if someone borrows £4,000 from you, you may charge £200 of interest to be paid back in equal instalments over 10 months (they pay £420 a month for 10 months for borrowing £4,000).

Remember that if you do charge interest it is taxable income in the eyes of Her Majesty's Revenue and Customs and must be declared as such.

Keeping records

Once you've drawn up the loan agreement, both parties should sign it in the presence of independent witnesses and each keep a copy. Now you can transfer the money to the borrower – do this in such a way that there is an indisputable record of the transfer, for example by direct bank transfer or cheque.

Once the loan has been transferred the loan agreement takes effect, and now the important thing is to keep records - of the initial transfer, and when and how much you have been repaid. Repayment by standing order is preferable.

Taking action if they fail to repay

If the borrower does not stick to 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 you can resolve it between you. You may wish to vary the terms in the initial agreement (to give them more time to repay, for example). In this case you must both sign the updated agreement with witnesses present.

If the loan agreement has been breached and you decide you want to get your money back, you can take legal action. For amounts less than £5,000 you should first approach the Small Claims Court. For larger amounts you will need to seek legal advice.

Useful documents 

Net Lawman offers two loan agreement templates that may be useful if you do lend to a friend or family member.

Unsecured loan agreement can be used where the borrower does not give any security or collateral, while Loan agreement: secured includes the option to do so.