How to protect family loans during divorce or separation

Borrowing money from family can be easier and more affordable than obtaining a formal loan from a bank or financial institution, which often makes it an attractive option. With rising property prices, it is increasingly common for couples to borrow from parents or other relatives to help pay for the deposit on their first home. Likewise, when it comes to separation, family members are often the first to step in and offer financial support, particularly with legal costs.

In both cases, it is important to be clear on what basis the funds are being provided – as a loan or, alternatively, a gift – and, if they are being loaned, what the terms of the loan are. Ultimately whether those family members will get their money back if the marriage comes to an end is something that the Family Court often has to consider.

How does the Family Court deal with loans made by family members?

The court makes a distinction between ‘hard’ and ‘soft ‘loans. ‘Hard’ loans are loans which must be repaid or financial consequences will arise, such as credit cards, mortgages and bank loans. Where loans are made from the ‘bank of mum and dad’ rather than a bank or financial institution, the position is often less clear. The court will decide whether a loan of this type is ‘hard’ or ‘soft’ by looking at the following factors:

Factors that point towards a ‘hard’ loan:

• the funds were lent by a finance company;
• there is a written loan agreement;
• the terms of the loan have the feel of a normal commercial agreement (for example, interest is charged on the loan);
• if deadlines for repayment have been missed, steps have been taken to enforce those payments (such as making written demands for payment, or applying to court to enforce repayment of the loan);
• the amount of money loaned is large enough that the lender is not likely to decide that the loan does not need to be repaid.

Factors that point towards a ‘soft’ loan:

• the funds were lent by a friend or family member;
• it is not clear what the borrower intended to happen with the money – i.e. whether it was a gift or a loan;
• there is no written loan agreement;
• the terms of the loan do not have the feel of a normal commercial agreement (for example, there is no timescale for repayment);
• the lender has not taken any steps to enforce repayment of the loan where payments have been missed;
• the amount of money loaned is small, so the lender is more likely to decide that the loan does not need to be repaid.

If a loan is considered to be ‘hard’ in nature, the amount owing will be earmarked for repayment. When determining a financial settlement, the court will take into account the fact that this loan will need to be repaid.

In contrast, when a loan is considered to be ‘soft’ in nature, the court may take the view that it does not actually need to be repaid. The court has discretion to ignore ‘soft’ loans when deciding how the assets should be divided between the parties. This means that the financial settlement might not leave the borrower with enough money to afford to repay the loan in addition to meeting their housing costs.

How can I ensure that family loans are taken into consideration by the court?

A court is more likely to take family loans into consideration where they look and feel as much like a commercial loan as possible. So if you or a family member are considering making a loan you may want to consider taking the following steps:

• sign a written loan agreement which provides for interest to be paid on the loan, and sets out a timescale and terms for repayment;
• comply with the terms of the loan agreement, including making repayments and payments of interest;
• if you have borrowed funds to help with the purchase of a property, you could register the loan agreement with the Land Registry and provide the lender with a legal charge against the property. This is how a commercial mortgage would typically be dealt with;
• ensure that each party to the loan has the opportunity to take independent legal advice at the time the loan is made.

If you require legal advice about this issue, please contact a member of our specialist family team who will be able to assist you.