If you have decided to ignore the well known advice of “don’t lend money to family or friends”, there are some very good reasons why you should create a legally binding, written agreement. This loan agreement between family members/friends and you, should outline a repayment schedule and what will happen if the borrower is late in repaying or if the borrower cannot repay at all because they go bankrupt or die.
Before entering into any agreement, it is highly recommended that you contact a contract lawyer. Our lawyers at Beger & Co are here to assist, so don’t hesitate to call us.
Overview:
- What a friend or family loan agreement includes
- Why you need a loan agreement
- Do I need security for the loan?
What a Simple Loan Agreement Between Family Members or Friends Includes
If you are going to take the place of a bank and loan money to a family member or friend, then it is important to make sure you act like a bank as much as possible. This includes:
- Asking appropriate questions about the borrower’s assets and liabilities and income and expenses so that you can make a proper assessment of your risk in entering into the proposed transaction.
- Agreeing on repayment terms and conditions (many family loan arrangements are simply payable on demand but this comes with risks). You also need to agree on charging interest (normal and default) and what constitutes a default.
- Deciding whether the loan will be secured or unsecured. If it is unsecured, one would expect a much higher rate of interest as the risk will be so much greater.
- Working out the best collateral or security the borrower (or their loved ones) can provide in case the borrower is unable to repay the loan.
- Agreeing who will pay the legal costs of having appropriate documentation drawn up (normally the borrower).
Why You Need a Loan Agreement Between Family Members or Friends
Arguably, if you lend money to family or friends it is more important to keep things on a commercial basis.
The reasons why loan arrangements between family members and friends should be properly documented include:
- Unless the agreement is committed to writing, it is all too easy to overlook important considerations.
- Lenders and borrowers often make different assumptions (especially about repayment deadlines).
- Engaging a lawyer to prepare documentation adds a level of objectivity to the transaction and the lawyer can advise on appropriate security.
- A secured loan between family members can be a very powerful estate planning It ensures the loan must be repaid in preference to other creditors and, importantly, that the loan will be repaid before property is divided in a failed relationship.
- A well thought out loan agreement (supported by appropriate security) will hopefully make both parties feel more comfortable about the transaction and avoid “bad blood” as a result of misunderstandings.
- The process of documenting the loan may cause some prospective borrowers to understand that just because the lender is a family member or a friend, does not mean the arrangement is casual or less important than a bank loan. I have seen some borrowers (and lenders) reconsider the whole arrangement when confronted with the commercial reality of the proposed loan (that it must be repaid strictly in accordance with the agreement and that the borrower (or a related party) stands to lose the secured property in a default situation).
Do I Need Security For a Loan Agreement Between Friends or Family?
Deciding whether security for a loan is necessary or not will depend on the circumstances and the size of the loan. Generally speaking, I recommend that a lender should always have security for the loan (and the more the better) when lending to family or friends.
Security may include any one or more of the following:
- Where the borrower is a company, a personal guarantee from the directors or shareholders;
- Where the borrower is an individual, a personal guarantee from the borrower’s spouse or parents;
- A registered mortgage of real property;
- An unregistered mortgage of real property secured by caveat;
- A mortgage or bill of sale over personal property registered on the Personal Properties Security Register (“PPSR”); or
- A security deed (fixed and floating charge) over company assets registered on the PPSR.
Before You Agree to a Loan Agreement Between Family Members or Friends…
If you decide to proceed with a loan agreement between family members or friends, I strongly recommend that you seek legal advice from a finance lawyer beforehand(even a one hour consultation could avoid a lot of heartache!).
At the very least, you should have a properly prepared loan agreement. With this, you will hopefully see the benefit of insisting upon the borrower (or a related party) providing appropriate security.
For further information on friend or family member loan agreements or debt collection, please contact Danny on 8362 6400 or email Danny Beger. Join our mailing list to receive updates and advice on current issues.
