Family loans arrangements – the hidden risks of family loans

With the Covid pandemic came global uncertainty and an exponential increase in interest rates. Six years down the line, mortgage rates remain high and buying a first home can feel increasingly out of reach. It is therefore no surprise that parents and grandparents are often asked to help younger family members fund a deposit or property purchase.

That help is frequently given as an informal, interest-free family loan. This can work well, but it should not be treated as a casual arrangement. A family loan can affect your tax position, your estate planning, your future cash flow and family relationships if expectations are not clear from the outset.

Is it a gift or a loan?

The first question is whether you want to make an outright gift or lend the money. If you make a gift, you give up control of the money and the recipient can use it as they choose. If that would be uncomfortable, a loan, or possibly a gift into trust for the benefit of family members, may be a better fit.

What about inheritance tax?

The inheritance tax treatment is different depending on whether the money is gifted or loaned. Broadly, an outright gift is usually treated as a potentially exempt transfer for inheritance tax purposes. If you survive for seven years after making the gift, it will usually fall outside your estate. If you die within that period, inheritance tax may be payable, depending on the value of the gift and the wider circumstances.

By contrast, a loan remains an asset of your estate because it is money owed back to you. Its value may therefore still be taken into account for inheritance tax on your death. If you later waive or release the loan, that release may itself be treated as a gift and start its own seven-year period.

Why put it in writing?

Even where everyone trusts each other, a written agreement is sensible. It records what has been agreed, helps avoid misunderstandings and provides evidence of the arrangement if the tax treatment is ever queried.

It also encourages everyone to think through the practical points at the outset, including:

• Affordability: can you comfortably lend the money without affecting your own lifestyle, retirement planning or future care needs?
• Security: should the loan be secured against a property or another asset? An unsecured loan may be harder to recover if circumstances change.
• Repayment: when should the money be repaid and will repayments be made regularly, on sale of a property or only on demand?
• Interest: will interest be charged and, if so, how will it be calculated and reported for tax purposes?

A clear agreement can be particularly important if relationships change, if the borrower separates from a spouse or partner, if either party dies or if repayment is later disputed.

What if you later waive the loan?

You may start with a loan but later decide that you do not want the money repaid. If so, the release should be dealt with formally and typically by deed. Simply telling the borrower that repayment is no longer needed, or recording this in a letter, may not be enough to release the debt legally. If the loan has not been properly released, it may still be treated as money owed to you and taken into account as part of your estate for inheritance tax purposes.

How can Cripps help?

Supporting family financially can be generous and worthwhile, but it needs careful thought. Before transferring money, it is worth taking advice on the right structure, the tax consequences and the protections you may need.

If you are considering making a family loan, our personal tax and succession team can help you decide what is appropriate for your circumstances and put the right documentation in place.