Lending money to friends and family is common in Australia. In the right circumstances, it can provide help in a time of need, and can be a satisfying way to assist someone that you care about. But it is also fraught with risk.
If you are lending money to somebody (ie if you are acting as a "lender"), then obviously there is the risk of losing your money if the person who borrows the money (ie the "borrower") does not pay it back. But in addition to this, there is the risk that a dispute over money could cause irreparable harm to your relationship. Many families and friendships have been torn apart by disputes over money.
Tragically, many of these disputes could have been avoided, if the parties took the right steps when setting up the loan.
So if you are considering lending money to a friend or family member, you must do it the right way. Record it in writing - this is vital. And make sure that everyone involved has a clear understanding of what is being agreed (and that the written agreement accurately reflects this).
We have several documents which can help you with this including our Loan Agreement and our Promissory Note. To keep our explanations simple, throughout this guide, we will refer mostly to a Loan Agreement. However, the issues we cover in this guide can apply to a Promissory Note as well.
A common source of disagreement regarding loans between friends and families is the question of whether the money has actually been provided as a gift or a loan.
For example, imagine a young couple who have just got married and are planning to buy their first house. The parents of one of them has chosen to help them out. The child and their spouse graciously accept the money, and put it towards their first home. Several years later, the couple splits up, and the spouse claims that half of the money is theirs. This might be the first time any of the parties involved even consider the terms on which the money was provided. The spouse is claiming that the money was a gift to the couple. The parents meanwhile are claiming that the money was a loan.
If the loan has not been recorded in writing, then it can be difficult to confirm what was actually agreed, and the (ex) spouse might be able to take off with half of the money.
Even in the case of simple loans between friends, with nothing in writing, it can be far too easy for well meaning parties to come to a misunderstanding.
For example, you might provide a sum of money to a close friend, to help them through a difficult period. Several years later, when they are back on their feet, you might ask them if they are ready to repay you. At this point you might learn that the friend thought the money was a gift. They might even be offended that you are now asking for the gift to be returned. Several years after having provided the money, you might actually struggle to remember what was really said at the time. Perhaps you didn't actually say that you expected the money would be repaid. And what about interest, was this even discussed?
Unfortunately, this is all too common. Different people, all well meaning and honest, can simply have a different recollection of what was said several years ago. Without a written agreement, it is easy to fall into this trap.
So the first thing that your Loan Agreement will do is clearly identify that the money is being provided as a loan rather than a gift. This can prevent a lot of headaches down the track.
We have both documents available on our website, and they are each suited to slightly different situations.
Generally speaking, a Promissory Note can be used for short-term, simple loans or offers of credit. It is a relatively simple document and is a good option when a person or company wishes to record a loan or promise to pay a small sum of money.
If you find a Loan Agreement too overwhelming or complicated for your purposes, then you may choose to use a Promissory Note instead.
On the other hand, a Loan Agreement may be used for more complex matters or when larger sums of money are being lent. A Loan Agreement contains various additional options such as a repayment schedule, guarantors, or security for the loan.
Whether you are lending money to a friend or family member, or are lending money on commercial terms to someone you do not know, it is important to consider whether the borrower is likely to be able to repay the money.
If you lend money to someone who is not going to be able to repay it, then obviously you are setting yourself up for problems in the future. So before advancing any money, you should think carefully about whether they are going to be able to repay it. It is also completely reasonable for you to ask for evidence of their ability to repay, such as bank statements, employment contracts or payslips.
If you have concerns about their ability to repay it, but still want to help them out, then you may choose to think about guarantors or security for the loan (discussed below).
If you are satisfied that the borrower is going to be able to repay the money, then it is worth thinking about how and when it should be repaid. For example, will they be making monthly installments, or will it be paid in one lump sum in a few years' time? It is a good idea to come to an agreement about these repayment dates, before the money is advanced. This way the borrower also knows what is expected of them, and is not caught off guard when you demand payment in future.
A guarantor is a person who receives no direct benefit from the loan (ie they receive no money from the lender) but takes on the responsibility to repay the loan on behalf of the borrower if the borrower fails to repay the loan.
For example, some Australian parents choose to act as guarantors for their children. This means that if the child borrows money, and is unable to repay it, the parents are responsible for repayment of the loan. This provides an extra layer of protection for the lender.
Guarantors are often used when the borrower does not have a strong financial position, but the guarantor does (for example, in the case of young adults in their first job, whose parents act as guarantors).
If you are concerned that the person you are lending money to may not be able to repay it, then you may think about whether it is appropriate for someone else to act as a guarantor. Of course, this also raises the question - why doesn't the guarantor just lend them the money instead?
However, if you decide that it is appropriate in your circumstances to lend money to the borrower, and to use a guarantor as well, then you may add one or more guarantors when you are filling out our Loan Agreement.
Often a borrower will provide "security" or "collateral" to a lender when borrowing funds. This security is an item of valuable property which the lender can recover from the borrower and sell if they fail to repay the loan. One common example would be the securing of a car loan against the borrower's car, so if the borrower cannot repay the loan, the lender would have the right to take possession of the car and sell it.
In some cases, you may be able to register a security interest on the Australian Government's Personal Property Securities Register.
Again, if you are concerned that the borrower may be unable to repay the loan, this is an option that you may consider. Our Loan Agreement provides the option of including security for the loan. If you need assistance with registering a security interest on the Personal Property Securities Register, then you should seek legal advice.
Securities law can be relatively complex so if you are lending a significant sum of money or if you have any concerns then you should seek legal advice. If the borrower has already provided the property as security to someone else, then you might run into problems down the track. For example, if the borrower bought their car using a finance arrangement with the car dealer, then the car dealer might have a security interest registered against the vehicle. If the borrower fails to repay you and you try to seize the car and sell it, you might be disappointed to learn that the car dealer is still owed a large sum of money, meaning they have the first priority in relation to the proceeds of sale.
By now we hope you understand the importance of making sure that all parties have a clear understanding of what has been agreed, before any money is handed over. All parties should keep a copy of the written Loan Agreement, which they can use as a point of reference along the way.
Here are some common terms for you to think about, and include in the Loan Agreement:
Simply by going through the process of preparing a written Loan Agreement, you will be forced to address questions in relation to these key issues. This is a good way to guide your discussion with the borrower, and to make sure you are both on the same page regarding the terms of the loan.
Once you have agreed on the terms on the loan and have provided the money to the borrower, keep a copy of the Loan Agreement on file so that you can refer to it in future if needed.
Keep track of any payments that the borrower makes. If the borrower misses repayments, it is usually best to promptly deal with the situation and to remind the borrower about their obligations. Otherwise, the borrower may get the impression that they do not actually need to comply with the terms of the loan, and they could continue to miss payments in future or avoid their other obligations under the agreement.
If the borrower is having trouble meeting their repayment obligations, it is usually better to have an open and honest discussion with them, and to come up with some sort of alternative plan together, rather than neglecting the issue and letting it blow up in future. For example, you might be able to come up with a way to reduce the borrower's monthly repayments, while extending the time in which they have to make repayments. Again, any changes to the agreement should be recorded in writing. We have a Contract Amendment document which can be used for this purpose. And if you are dealing with this sort of situation, you should strongly consider seeking legal advice.
Once the loan has been paid in full, the parties should prepare a Release of Loan Agreement. This document provides a written record, which both parties can keep, confirming that the matter has been finalised and the borrower has no further obligations under the Loan Agreement.
Lending money to friends or family is not necessarily something that you need to avoid altogether. However, if it is not done correctly, then there is a good chance that you will lose money and destroy relationships.
Therefore, you need to think carefully about the terms of the loan, and you need to make sure that you have a written record of what has been agreed. Make sure that the borrower also understands the agreement and is happy with it. For simple loans, our Promissory Note may be helpful. For larger or more complex loans, our Loan Agreement may help. If in doubt, seek legal advice.