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Family gifts or loans — how to protect yourself

By May 8, 2018October 26th, 2021No Comments

There’s a great article in In The Black on the dangers of lending to family and friends, how you can minimise the risk of not being repaid, and what the difference is between family gifts or loans.

The article tells the cautionary tale of a family loan dispute case last year, where a son refused to repay his parents the $280,000 they had lent him over a number of years to help with his business and personal needs.  The parents had no documentation proving the monies had been provided as a loan, and the son insisted the monies had been a gift.  The judge found that although the son had “cynically abused [his parents’] generosity”, there was no binding loan agreement and no obligation to repay the funds. The parents, however, appealed and the son was ultimately ordered to repay his parents–with interest.

But the protracted court proceedings could have been avoided had the parents sufficiently documented the loans to their errant son.

These loans are not only relevant in commercial matters, but can also end up having a big impact on a family law property settlement. If a loan is accepted by the judge as a genuine loan, then a matrimonial asset pool will be decreased by the size of the loan. If it is treated by a judge as a gift, it can represent a potentially large contribution by that side of the family in favour of that spouse.

Family loans, also known as interpersonal loans, are believed to be a massive informal lending market, on some estimates worth billions of dollars a year. These “invisible loans” are unfortunately rarely documented and therein lies the rub.  Without documentation, these loans can become muddled up as loan-gifts, and become legally opaque.

Popular as a source of finance for small business ventures, there is evidence that interpersonal loans actually rival commercial loans in size. Despite this, family members who are considering lending to family or friends rarely seek independent advice on the transaction. And in fact, family gifts or loans for business purposes often cause the most problems because they are the least professionally handled:

Parents cannot scrutinise a prospective business in the same way as a professional, who would know that determining risk is part of the process.

The other main reason for interpersonal loans is borrowing to enter the property market.  There is said to be “phenomenal growth in the family guarantee, which allows borrowers with little or no deposit to finance a property”.  A borrower’s parents provide a limited security guarantee secured against their home, an investment property or a sum such as a term deposit. But the danger is that the younger generations want to bypass the traditional slow and steady march up the property ladder, in favour of zooming straight into expensive suburbs and borrowing vast amounts to cover higher purchase prices. And the instant mortgage stress they experience can have dangerous consequences for the parent-lender.

A family acting as guarantor must be absolutely certain that the amount they’ve guaranteed is actually repayable, given the serious repercussions that can occur, from a destroyed credit rating to being made bankrupt and forfeiting assets that weren’t even originally offered as security.  For this reason, the experts warn that families should never, ever offer an unlimited guarantee or responsibility for fees, charges and interest.

The experts advise that to mitigate the possibility of future disputes, families considering interpersonal loans need to treat the transaction as if it were a commercial loan and be clear about whether the funds are family gifts or loans.  This means preparing documentation and paperwork that stipulates the exact loan terms and repayment schedule. On the question of who would review such documentation, experts say that family members might choose an independent advisor, or set up a ‘family investment committee’.  There’s no definition of sufficient documentation for a loan, but having a loan agreement makes a loan’s existence more credible and helps ensure it can be included on a balance sheet as a liability. Likewise, a regular repayment history or the existence of lump sum repayments helps validate a loan’s existence.

Families should strive for open, frank communication and a discussion between family members to settle “a family wide policy on the provision of family capital”, say the experts. This sets clear expectations on all sides and helps clarify when funds are advanced as part of an entitlement to a future estate.

It’s when the more nebulous loan-gifts are made that things get confusing. What is a loan and what is a gift? It’s a bit of a grey area, but loans and gifts are treated differently in taxation and law.

Say an adult son or daughter was married and the couple borrowed money from family to buy a property. If the relationship ends, and the money was a gift, it will be considered part of a couple’s assets and assessed in the break-up. 

If the money was a loan to one person in the couple, however, the asset pool drops in value once the loan is factored in. The court may order one spouse to repay the loan, or both, or potentially neither of them if appropriate in the circumstances.

Read more, including about the family loan scenario that is now subject to new rules from the Australian Taxation Office:  In The Black

Alliance Family Law recommends legal advice be sought at the time of entering into the loan with either the parents getting their own legal advice, and the borrower in relation to their family law situation at the time. It may be appropriate to consider entering into a binding financial agreement at the time. These matters should be the subject of legal advice at the time of entering into the transaction.

Do you need assistance with a property settlement, Will, binding financial agreement or other family law matter? Please contact Canberra family lawyer Cristina Huesch or one of our experienced solicitors here at Alliance Legal Services on (02) 6223 2400.

Please note our blogs are not legal advice. For information on how to obtain the correct legal advice, please contact Alliance Legal Services.

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