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Borrowing money from family

27/04/2020
The bank of mum and dad (BOMAD) is the phrase used when children are borrowing money from family to buy a house. The question is whether it is borrowed, meaning it is a loan to family, or is it a gifted deposit. When loaning money to family there are certain things to consider:

  • Is the loan a Regulated Mortgage Contract?
  • What is the interest rate or is it an interest free loan?
  • When is the loan to be repaid?
  • Can the loan be repaid early?
  • Will the mortgage lender allow it?
  • What are the tax implications for a loan to family?

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 the lender and the borrower to protect both parties. 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 a someone provides a loan to a family member 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, it states:

(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:

  • Consumer Credit Act Compliant Loan Agreement
  • Providing the borrower of 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 giving a loan to a family member 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 essence an interest free loan to family. Something to consider is that if the loan to your relative was 10 years ago, then the value of the capital repaid is worth less than when you loaned the money. This is why family members often agree for the loan to be repaid plus interest linked to Retail Price Index (RPI).

A further consideration on the interest applicable to the loan is that a loan to a family member has tax implications. We explain what these are further on.

    3

    When is the loan to be repaid?

Loans to 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 to 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 
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borrowing money from family to buy a house

    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 from family. You should speak to your mortgage lender and see if they will agree to offer you a mortgage if you are also borrowing from friends and family.

    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. You can read more here - Peer to peer lending.

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.

Frequently Asked Questions

Does the family loan agreement need registering?

It isn't mandatory to register the loan agreement at the Land Registry, however by not doing so it exposes the lender to not getting repaid their loan on the sale of the property. Whilst you would hope the loan to be safe with the borrower when borrowing money from family, time can change relationships so it is always safest to secure the loan against the property.

A solicitor can register a charge on the property for you using a Land Registry Form CH1.

Family loans can be reviewed by the courts

The borrower could make an application to court to review the fairness of the loan. The courts could look to change the terms for repayment of the loan. If you require support in the drafting of a loan agreement then call us on 0333 344 3234.

Summary
The objective of helping your children or relatives into a home to live in is clear, however when Borrowing money from family to buy a house you have to look beyond this goal. Do you want to see that money again? Are you trying to make a profit? Could you afford to not be repaid for 10 or 20 years? Agree some of these basic questions at the outset before you give the loan and you'll have less surprises in the future. If you have any questions then please get in contact.
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