Borrowing from or lending to family and friends

Borrowing money from family, or lending to a friend, is one of the most common ways people in the UK cope with a shortfall. Official statistics on the cost of living crisis found that borrowing from friends and family increased during that period, alongside other forms of debt such as energy and council tax arrears¹. It is quick, it usually costs nothing in interest, and no credit check is involved.

It is also one of the least formal kinds of borrowing, and that is where the problems start. A loan between people who know each other is legally real: the debt can be pursued through the courts like any other unsecured debt, and the same money can create tax, inheritance and benefits complications that neither side expected². This page explains how a family loan works, how to tell a loan from a gift, what to write down, what the tax rules are, and what happens if things go wrong.

How a family loan works

A family loan is simply money that one person lends to another, usually without a lender, a credit check or a formal application in between. What makes it different from a bank loan is everything that surrounds the money rather than the money itself. A bank loan is a formal arrangement, usually for a fixed period of time that you agree at the start, with a repayment schedule, an interest rate and consequences that are set out in writing before you sign⁷. A loan between relatives often has none of that: the amount, the timing and even whether it is a loan at all can be left to memory and goodwill.

That informality is the attraction and the risk. Because there is no lender assessing affordability, the borrower may be able to get money that no bank would lend them, which can be a lifeline or a trap depending on whether the repayment plan is realistic. Because there is no contract, the two people may genuinely disagree later about what was agreed: whether £2,000 was a loan or a birthday gift, whether repayment started in March or "when things pick up", whether interest was ever mentioned.

A family loan is sometimes used to clear other debts, in the way a debt consolidation loan works: you work out how much you need to borrow to pay off all your debt, borrow that amount, and use the money to pay back each creditor, leaving one repayment⁸. Doing this with family money rather than a commercial loan avoids arrangement fees and interest, but it concentrates the debt in the hands of someone you see at Christmas.

If the reason for borrowing is a short-term gap in essential spending, there are alternatives worth knowing about before asking family. StepChange, a debt charity, lists safer ways to borrow than from family or friends, including credit union loans, using an authorised overdraft, loans or help from a local authority, a wage advance from an employer, and a budgeting loan or advance from the DWP if you receive benefits². Budgeting loans from the Social Fund are themselves assessed on factors including the number of people in your household, any money already owed to the Social Fund, your ability to repay and your savings⁹. The credit unions page explains how that option works, and making a budget first will show whether the loan is genuinely affordable.

Loan or gift: the difference matters

Whether money that changes hands between relatives is a loan or a gift is not just a matter of what people intend at the time. It changes who owns the money, what happens if either person dies, whether tax is due, and what evidence exists if there is a disagreement.

A loan creates a debt. The money still belongs, in economic terms, to the lender, and the borrower is expected to return it. A gift transfers ownership completely: once given, the money belongs to the recipient, and the giver has no claim on it, whatever the relationship does later. Many family disputes about money are really disputes about which of these two things happened, because the word "loan" is sometimes used loosely for money that the giver never expected to see again, and the word "gift" is sometimes used for money that the giver quietly expects back.

The difference matters in several practical ways:

• Repayment: a loan can, in principle, be recovered through the courts like any other unsecured debt; a gift cannot²
• Inheritance: an unpaid loan is an asset of the lender's estate when they die, while a gift may be subject to Inheritance Tax rules depending on when it was made and to whom¹⁰
• Tax: interest received on a loan is taxable income; a gift generates no income for the recipient to declare⁴
• Evidence: a written agreement signed by both people is the clearest proof of which it was

If money is a gift, the cleanest thing the giver can do is say so in writing at the time, and if it is a loan, the same applies. Ambiguity is what causes the damage later, particularly after a death or a separation, when people who are grieving or in conflict have to reconstruct what was intended years earlier.

Putting the agreement in writing

There is no legal requirement for a private loan between family members or friends to be in writing. The agreement is valid if it can be shown to exist. But some contracts, such as formal credit agreements with lenders, must be in writing, and the reason is instructive: writing things down removes any argument about what was agreed¹¹. A family loan benefits from exactly the same discipline.

A written family loan agreement does not need to be drafted by a lawyer. A single page, signed and dated by both people, covering the essentials, is enough to prevent most disputes. What it should contain:

• The names of the lender and the borrower
• The amount lent, and the date the money was handed over
• Whether interest is charged, and if so how much and how it is calculated
• When repayment starts, how much each instalment is, and how often
• What happens if a payment is missed, and whether the lender can ask for the whole amount back at once
• Whether anyone witnessed the signatures

On witnesses: there is no requirement for a private loan agreement to be witnessed, but an independent witness adds evidence that both people signed willingly and understood what they were signing. Official forms sometimes set the standard explicitly: the Court Funds Office requires that you and a witness sign and date the form on the same day, and that the witness is someone who knows you, such as a teacher or doctor, but not a relative¹². Choosing someone outside the family to witness a loan agreement follows the same logic.

Writing also protects the borrower. Shelter Cymru notes that a person may need to challenge responsibility for a loan if they were put under pressure by another person to sign, or were misled by a lender⁶. A clear, freely signed agreement protects both sides against exactly that kind of claim.

Charging interest, and what that means for tax

Most family loans charge no interest, and that keeps things simple. Where interest is charged, even a modest rate, it turns the lender into someone receiving income, and that income is taxable.

The rule is the same one that applies to bank and building society interest: you pay tax on any interest over your allowance at your usual rate of Income Tax⁴. Interest on savings is paid gross, meaning without tax deducted, and you might have to pay tax on it if it is above your Personal Savings Allowance¹³. The same principle applies to interest a relative pays you: the fact that the payer is a family member rather than a bank does not make the interest tax free.

In practice this means:

• If the loan charges no interest, there is no interest income and nothing to declare on that front
• If interest is charged, the lender needs to keep a record of what was received and declare amounts above their allowance
• The Personal Savings Allowance, which governs how much interest you can receive tax free, applies to interest income generally, not only to bank accounts¹³

A lender who wants to charge interest should also write the rate and the calculation method into the agreement, so the borrower knows what the total cost will be and there is no dispute about how the figures were worked out. Interest that is agreed verbally and calculated differently by each side is a common source of conflict.

One further point for anyone lending at interest as more than a one-off: lending money to the public as a business is a regulated activity, and it is illegal to solicit or canvass to sell credit away from premises unless a prior request to borrow has been made in writing¹⁴. A one-off loan to a relative is nothing like this, but someone who finds themselves lending repeatedly, at interest, to people they do not know, should take advice before going further.

Gifts, loans and inheritance tax

Inheritance Tax is charged on the estate of someone who has died, and both gifts and unpaid loans can affect the bill. The starting point is that when someone dies, the value of their estate has to be worked out, and you will normally have to start paying Inheritance Tax before probate is granted¹⁵.

Gifts made while the person was alive can form part of the taxable estate, depending on when they were made and to whom. Where gifts total more than the nil rate band for Inheritance Tax, the tax is due on the gifts themselves and is paid by the recipients of the gifts¹⁰. This is a point that surprises people: the tax on lifetime gifts above the nil rate band falls on the people who received them, not on the estate as a whole. A family member who received a large gift may therefore face a tax bill of their own years later.

An unpaid loan works in the opposite direction. Money that is still owed to the person who died is an asset of their estate, and the executor or administrator can pursue it. The outstanding balance increases the value of the estate, and the borrower may find themselves repaying the loan to the estate, or having it deducted from their own inheritance if they are also a beneficiary.

Where Inheritance Tax is due and cannot be paid at once, it can be paid in yearly instalments, and you will usually have to pay interest on those instalments¹⁶. Interest on unpaid Inheritance Tax is charged from the first day of the seventh month after the month in which the person died¹⁷. These timing rules matter to a family that is also dealing with an unpaid loan, because the estate may need the loan repaid in order to pay the tax.

One group needs particular care: attorneys and deputies who manage money for someone who lacks capacity. If you want to make gifts to reduce the impact of Inheritance Tax while acting for someone else, you may need to make an application to the court first¹⁸. An attorney cannot simply "forgive" a loan or make gifts from the person's money on their own authority.

Using family money for a house deposit

Family money is involved in a large share of first-time purchases, usually as a deposit. This is the setting where the loan-versus-gift distinction matters most, because mortgage lenders ask about it directly.

When you apply for a mortgage, most lenders will tell you how much money they are willing to lend you, called a mortgage agreement in principle¹⁹. That figure is based on an assessment of your income, outgoings and existing debts. A mortgage lender will base the application on several things including your credit file, the value of the house, and how much you want to borrow²⁰. A family loan sitting in your bank account is a debt in the lender's eyes, and it will be treated differently from a gift.

This is why lenders usually ask the giver to sign a deposit gift letter: a short statement confirming that the money is a gift, that the giver has no stake in the property, and that they do not expect repayment. Without it, the lender may assume the money is a loan, count it as a commitment in your affordability assessment, and reduce what they will lend.

If the money really is a loan, the honest course is to say so. The lender will then factor the repayments into the affordability calculation, and the family loan agreement should be available as evidence of the terms. Concealing a loan as a gift can cause problems much later, including when the lender discovers the true position. The buying a home and mortgages pages cover the rest of the purchase process.

What if the borrower cannot repay?

Non-payment is where an informal arrangement meets the formal machinery of debt recovery, and it is worth knowing how that machinery works before lending, not after.

The first thing to say is what does not happen. Not repaying a debt is not a criminal offence. Official guidance is explicit that it is not a criminal offence to fail to repay a debt, so no lender, licensed or otherwise, can bring criminal proceedings about arrears²¹. The same guidance states that not repaying a loan from an unlicensed lender is not a crime, and threats of prosecution and prison cannot happen²². A family lender who threatens a borrower with the police or prison is not only wrong, they may be committing harassment.

What can happen is civil recovery. Debts owed to family or friends can be pursued through the courts like any other unsecured debts². The formal route runs in steps:

1. Ask for the money and try to agree a plan. A changed repayment schedule, agreed in writing, resolves most cases.
2. Make a statutory demand. Anyone who is owed money, the creditor, can make a statutory demand, and you do not need a lawyer³.
3. The borrower responds. The debtor's options are to pay the debt or reach an agreement to pay³.
4. Go to court. If they ignore the statutory demand or cannot repay the money, you can apply to a court to make someone bankrupt²³.

If the dispute reaches a formal court claim, the person being sued can also make a claim against the other party, a counterclaim, if they think they are owed money, though a court fee may be payable²⁴. In a family dispute this is not unusual: one side claims the loan, the other claims money spent on the other's behalf over the years.

Bankruptcy of a relative over a family debt is a serious step, with costs and consequences for the person applying as well as the person made bankrupt. Free debt advice, covered at the end of this page, should be the first port of call for both sides.

If the lender or borrower dies

Death changes a family loan in ways people rarely plan for, and the rules are not what most people assume.

If the borrower dies, the debt does not simply vanish, but nor does it fall on the family. Creditors are not entitled to pursue family members for payment from their own funds, but they may claim against the estate if there are assets⁶. So the executor of the borrower's estate should repay the family loan from the estate before distributing what is left. If the person who died had no assets, the debt is not recoverable, and family members should send a copy of the death certificate to creditors⁶.

If the lender dies, the unpaid loan becomes an asset of their estate. The executor can call it in, and the borrower may have to repay the estate even though their relative has gone. This is one of the strongest arguments for writing family loans down: an executor who knows nothing about a verbal loan cannot collect it, and a borrower who has repaid nothing has no record of what was owed.

Where the loan is connected to a home, the position can be more involved. If a mortgage lender required life insurance, that may pay off the full amount of the loan; if there is no insurance, or for second mortgages not covered, the property may have to be sold²⁵. Government loans against a home work similarly: with a Support for Mortgage Interest loan, a partner who lives with you can usually inherit the loan with the home, but anyone else who inherits, such as a child or a friend, will need to repay the loan immediately²⁶. A private family loan secured informally against a property has none of this machinery, which is another reason family loans for house purchases need clear written terms.

Protecting the relationship: agreeing terms before the money changes hands

The financial risk in a family loan is usually smaller than the personal one. The money may be affordable to lose; the relationship may not be. Most of the damage comes not from the default itself but from mismatched expectations, and those are set, or prevented, before the money moves.

The practical safeguards are unglamorous:

• Agree the terms out loud first, then write them down. Amount, dates, instalments, interest or none, and what happens on a missed payment.
• Be honest about affordability. A borrower who cannot realistically repay is being set up to fail, and a lender who needs the money back soon should say so.
• Treat a large loan like the formal commitment it is. Anyone considering being a guarantor for someone else's borrowing is advised to get independent legal advice and talk to a mortgage adviser before agreeing to it²⁷. The same caution suits a large family loan.
• Where a guarantee is involved, disclosure is a legal right. Under FCA rules, before making a guarantor credit agreement the firm must provide the guarantor with an adequate explanation of when the guarantee might be called on and the implications, plus the necessary product information²⁸. A family lender asking someone to guarantee a loan should volunteer the same information.

There are also lines that must not be crossed when chasing money owed. StepChange warns that adding extra money or "interest" without agreement, telling other people about the debt, losing your temper or using threatening language are likely to make the other person avoid you, and you could even be breaking the law². A lender who harasses a borrower over a family loan can commit a criminal offence, whatever the debt's merits.

Finally, both sides should consider whether a family loan is the right instrument at all. The safer alternatives listed earlier, from credit unions to budgeting loans, keep the debt at arm's length and preserve the relationship². The couples and money page covers some of the same ground for partners, and free help if someone pressures you over money exists for the harder cases.

Credit files and family loans

A family loan lives outside the credit system. Credit reference agencies hold a file on you if you have ever had a credit card, a loan or a mortgage with a regulated lender⁵. A private arrangement between relatives is not reported to them, so repaying a family loan on time builds no credit history, and missing payments on one damages none.

That cuts both ways. A borrower with a thin or damaged credit file cannot use a family loan to repair it, and may be better served by a small credit union loan or a credit builder card that does report. The credit scores page explains how files are built.

The indirect effects are real, though. When you later apply for a mortgage or another loan, the lender assesses your existing commitments, and a family loan is a commitment even if it is invisible to the agencies. If you are in arrears with your mortgage or other debts, your credit rating will be affected and it is unlikely you will get a good mortgage offer²⁰. Lenders rely on what you tell them as well as what the file says, and failing to disclose a family loan on an application can count against you if it later comes to light.

Where to get free help with debt or money disagreements

Nobody should have to pay for advice on a family loan, and free, independent help is available whatever the situation.

For the borrower who cannot repay, free debt advice comes first. You can get free and independent advice on debt management plans, or any kind of debt problem, from organisations such as Advice NI in Northern Ireland²⁹. The Financial Services Compensation Scheme signposts people struggling with repayments to free debt advice from StepChange, Which? and Citizens Advice³⁰. Informal arrangements with creditors, where you negotiate reduced payments directly, can also be discussed with free advisers before committing to anything³¹. The debt section brings the full range of solutions together.

For the lender, the same charities can talk through the recovery options, including whether a statutory demand or court action is proportionate to the amount and the relationship³. For disputes that are more personal than financial, mediation services exist outside the financial system, and a conversation helped by a neutral third party is far cheaper than a court claim.

For both sides, the earlier the help, the better. A budget drawn up with an adviser before the loan is made, using a free budget planner, answers the affordability question honestly. Advice sought after a default answers a harder one.