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Loan Agreements for Family and Friends

Loan Agreements for Family and Friends
14 December 2017

There are all sorts of ways of lending and borrowing money these days.   When the lender is a high-street bank it's very clear that you are entering into a formal loan agreement since there will lots of official paperwork to sign.  It may not be so clear if you're borrowing from a family member or friend.

We get used to the idea that the only place to borrow money is from an official institution.  But lending to or borrowing from family members can be a viable alternative.  A simple written loan agreement can help put the loan on a more 'formal' footing than a simple verbal agreement.  A verbal agreement can still be a legally enforceable contract, but is far more open to misunderstandings and more difficult to show what the terms of the agreement were should a disagreement later arise.

Lending to Family and Friends

If you're thinking of loaning money to a family member don't feel embarrassed to talk about the terms of the loan with the borrower.  We're a nation of people notoriously reticent about discussing money matter, when we shouldn't be.   If you've agreed to loan a significant sum of money (and we're not talking about £20 for a round of drinks), then there's no reason why you shouldn't discuss things such as:

  • when the loan should be re-payed
  • when it should be re-payed in a single amount, or a number of payments
  • whether or not you will charge interest.

A written loan agreement does not have to be a complex document.  The key things to cover are:

  • The names of the borrower and lender
  • The amount of money being borrowed
  • The interest rate being charged (if any) and how it is calculated
  • Repayment terms – the amount and frequency of repayments (instalments)
  • A prepay clause if you want to impose a fee for early repayment of the loan.

Simple Fixed Term Loan

The simplest form of loan agreement you can use would be a fixed term loan without security or guarantee. For a simple fixed term loan, the repayments are usually equal amounts payable at regular intervals.  The repayment amount needs to be correctly calculated so that the loan and any interest is paid off in full at the end.

A personal lending agreement would typically specify an annual interest rate (or no interest rate) and fixed monthly payments.  If you're drafting a lending agreement yourself make sure you do the calculations correctly:  you can't just multiply the loan amount by the interest rate and divide by 12. There are online tools that can  help such as this loan repayment calculator.

Loan Repayments

If you're making a personal loan to a family member then you will probably want to keep the terms relatively straightforward.  A simple lending agreement that has a fixed interest rate and regular monthly repayments is probably sufficient.  More complex loan terms such as penalty payments for early repayments, varying interest rates, guarantors and security are clauses more commonly found in commercial loan agreements.

Tax Implications

If you're earning interest on money you've loaned to someone then you may have to pay tax on the interest.  You would need to declare any interest you earn as taxable income on your annual self assessment tax form.  If you are not charging any interest on the loan then no tax will be due.

Many loan agreements allow early repayment of a loan.  Formal arrangements often charge a fee for early repayment to cover their admin costs but that's unlikely to be an issue when borrowing from an informal lender.  Still, it's something you should discuss with whoever is lending.  Make sure your loan agreement includes a clauses that says what happens if you want to repay the loan early.

Legal Obligations

Whoever you borrow from: a bank, loan company or friend you still need to be sure you can meet the monthly repayments.  Having a written agreement in place, signed by both you and the lender, records the details of the contract.

If you don't make the agreed repayments then you would, technically, be in breach of contract. A friend or family member may be a lot more flexible than a financial institute if you are late with a payment.  But a contract is a legal agreement and if you continually fail to repay the loan and can't reach an agreement with your lender, they could take court action if they want the loan repaid.  But that's a worst case scenario.

If you are borrowing from a family member then our top tips are:

  1. do a budget and make sure you can afford the repayments
  2. discuss all aspects of the loan up-front with the lender
  3. use a model loan agreement to make sure you cover all the main points
  4. have a written agreement in place
  5. stick to the terms of the agreement.

Loan agreement Template

If you're ready to draft a loan agreement then you could use a solicitor, draft it yourself or use a loan agreement template such as ours.  There are plenty of on-line providers of loan contract templates.  However you choose to draft your loan agreement, make sure it is correctly signed and witness and store your copy in a safe place.

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