Should I Draft a Formal Loan Agreement for a Family Loan?

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Table of Contents

• Do You Expect a Repayment?
• Is Repayment Necessary?
• Key Takeaways

Parents always want the best for their children, and in a competitive property market, this often means financially assisting them when they purchase a home. Transferring money between family members is very common and seems like a simple task. However, from a legal perspective, you should take note of numerous considerations. This article sets out the importance of why you should draft a formal loan agreement.

Do You Expect a Repayment?

Before transferring money to your child or family member, take some time to consider whether you expect a repayment. If you would like a repayment, it is essential to structure the transfer as a loan rather than a gift. While a verbal agreement with the intention of repayment may be easy, an agreement in writing is best. Having a written agreement provides you with security especially if the relationship sours or there is a misunderstanding. A written agreement ensures both you as a lender and your family member as the borrower are clear of the terms of the loan, including the repayment.

If you need to resolve a dispute through a dispute resolution mechanism, for example, negotiation or mediation, a more formal agreement is likely to be considered a loan. In contrast, a verbal agreement usually lacks typical commercial terms and is more likely to be seen as a gift.

Having a lawyer draft your loan agreement with key commercial terms improves the probability of your transfer legally being considered a loan. Including an interest clause in your written agreement suggests that you provide money with the incentive of a financial return. Without the inclusion of a financial incentive like interest, the loan is likely to be altruistic and therefore a gift.

Is Repayment Necessary?

You may be in a stable financial position and want to help out your children. If so, when transferring money you may not intend on any repayments. However, even if you feel repayment is not currently necessary, you may change your mind later down the track. For example, your financial circumstances may change, or you may feel differently about repayments if your child shares that money with a third party such as a de facto partner or spouse. Therefore, it is best practice to have the option to request repayment. Even if you have no intention of requiring repayment, it is essential to account for the uncertainty of the future.

Future Financial Needs

If in the future, you find yourself in a position requiring extra funds, it may be necessary to recoup the money you provided to your child. If they are unwilling to pay, without a loan agreement, the transfer will likely be considered a gift. Accordingly, it may be best to draft a proper loan agreement with a payable on demand clause before transferring funds. Such provision provides you with a choice to request repayment should you need to.

Alternatively, if you do not want or need a repayment in the future, you don’t need to use the clause. Be careful when using a payable on demand clause because the more time that passes without you making that demand, the more it is likely to look like a gift. Further, it is essential to keep in mind time limitations as your right of demand may expire.

Ultimately, having a loan agreement will provide you with better grounds on which to request repayment. However, there is no guarantee that a court will view your arrangement as a loan. A court typically relies on analysing a variety of considerations and the specific circumstances of your situation. Therefore, regardless of what you call your agreement, or if you have no intention to demand repayment the court may consider your agreement to be a loan if it looks and intends to act like one.

Sharing Money with Third Parties

If your child shares the money you provide them with a third party, for example, a de facto or married partner, you may wish for a repayment. Including an on-demand clause for payment in your loan agreement may be useful in this situation. The clause will allow you to request repayment as you desire. However, as previously stated, it is important to use such clause with caution.

Upon involvement of a third party, it is best to include them in the agreement. At the very least you should ensure that the third party is aware of and acknowledges the existence of the loan and the payable on demand clause.

Key Takeaways

When lending money to your child, it is important to consider whether you expect a repayment. If so, having a lawyer draft a formal loan agreement with essential terms and signatures from all parties will help in ensuring your arrangement is a loan rather than a gift. Even if you intend to offer the money as a gift, having a formal loan agreement including a payable on demand clause, accounts for the uncertainty of the future. However, when using a payable on demand clause, it is important to take note of the timing and associated time limitations.

If you have any questions about formal loan agreements or would like assistance in drafting one, get in touch with one of LegalVision’s banking and finance lawyers on 1300 544 755.