Loan Agreement Between Family Members

The bank of mum and dad (BOMAD) is the phrase used when children are borrowing money from family to buy a house, however lending money can be from anyone in the family including grandparents and siblings.

The question is whether it is borrowed, meaning it is a loan to family, or is it a gifted deposit.


We will answer each of these and explain how to work around problems when borrowing money from family to buy a house. What is most important is that you have a written loan agreement between family members to protect both the borrower and the lender.

Home ownership can last for a long time and relationships can change, the lender may need the money back and there may even be an argument over whether it was a loan in the first place, or whether it was a gift. We draft loan agreements at affordable prices so get in contact if you need our help.

1

Is the loan a Regulated Mortgage Contract?

Where someone provides a loan agreement between family and the borrower is going to live in the property, then it could become a Regulated Mortgage Contract under The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001, Section 61 - Regulated Mortgage Contracts, as stated:

(a)a “regulated mortgage contract" means a contract under which— (i)a person (“the lender") provides credit to an individual or to trustees (“the borrower"); and (ii)the obligation of the borrower to repay is secured by a first legal mortgage on land (other than timeshare accommodation) in the United Kingdom, at least 40% of which is used, or is intended to be used, as or in connection with a dwelling by the borrower or (in the case of credit provided to trustees) by an individual who is a beneficiary of the trust, or by a related person;

The Financial Conduct Authority (FCA) provides a more detailed explanation of what is a Regulated Mortgage Contract here - PERG 4.4 What is a regulated mortgage contract?

When borrowing money from family, where the loan is secured over land and there is an interest rate of 2% or more, then the obligations of the lender are more onerous such as:

• Using a Consumer Credit Act compliant loan agreement
• Providing the borrower with an annual statement of interest and payment received;
• Notifying the borrower of changes in interest rates or payments due under the contract, or of other matters of which the contract requires him to be notified; and
• Taking any necessary steps for the purposes of collecting or recovering payments due under the contract from the borrower.

2

What is the interest rate or is it an interest free loan?

As we've seen above, having a high interest rate makes a loan agreement between family members a more complicated affair with the need for regulated loan agreements. This may not be your intention. It may be that you are happy to just get the amount borrowed back in an interest free loan to family.

Something to consider is that if the loan to your relative was made 10 years ago, then the value of the capital repaid is worth less than what it was when you loaned the money. This is why family members often agree for the loan to be repaid with an interest linked to Retail Price Index (RPI).

A further consideration on the interest applicable when making a loan agreement between family is that lending money to a family member has tax implications.

3

When is the loan to be repaid?

Loan agreements between family members are difficult to get repaid early if they are tied into the sale of a house to repay the debt. Can you afford to be repaid in 10 years' time? Most loan agreements are repayable on sale, or if the terms of the loan agreement are breached, on a court order for sale.

If the loan agreement allows for repayment on a monthly basis, then you may find the first charge mortgage lender is not happy with this. If there is no mortgage lender, then the other consideration is whether the borrower can afford to satisfy the monthly repayments.

To avoid Inheritance tax implications, you should think about an 'on demand' repayment, however this has risks for the borrower. On demand quite literally means "must be repaid on the demand of the lender". In practical terms, it is highly unlikely the loan could be repaid on demand without the home owner having to sell their property to repay the loan.

4

Can the loan be repaid early?

Most loan agreements allow for the early repayment of the loan to the family member. The loan agreement should allow for the borrower to repay the loan early.

5

Will the mortgage lender allow it?

If the borrower is also getting a first charge mortgage, then that mortgage lender will need to agree to the loan. Some mortgage lenders won't agree to additional funding from a loan agreement between family.

You should speak to your mortgage lender and see if they will agree to offer you a mortgage if you are also securing funds through a loan agreement between family members.

6

What are the tax implications* for a loan to family?

Interest

Income tax is payable at the prevailing rate on interest on peer to peer loans.

Inheritance Tax

Inheritance tax shouldn't be ignored when assessing the tax implications for a loan to family. From an IHT perspective, if the loan is repayable on demand, then the value of the lender’s estate is exactly the same before and after the loan is made and prevents the loan being treated as a ‘transfer of value’ which may be subject to IHT.

The value of the asset when assessing IHT remains the same as the original loan. Any increase in the debt, such as income or penalties fall outside of the deceased lender's estate.