It is not uncommon for newlyweds to borrow money from parents and other family members, either to raise money for a deposit on a first home or to meet other expenses in the process. important capital during a marriage.
Borrowing from a family member can be more accessible and affordable than applying for a loan from a formal lender, and therefore can be an attractive option when family members are ready to lend a hand.
However, it is important that these family members think in advance about how to formalize the loan, to ensure that they will still get their money back if the marriage fails before the loan has been repaid. .
Once the financial recourse procedure has started, both spouses must declare all their assets, liabilities and income to the court. It’s a relatively simple principle that the court needs to know the size of the cake before they can start cutting it.
However, not all liabilities are treated the same. The court distinguishes, for the purposes of financial recourse procedures, between the broad categories of “firm loans” and “loans at preferential rates”. This is not an explicit distinction in the law, and therefore there is no clear definition of the terms – there is a large degree of judicial discretion.
What is a hard loan?
Simply put, a “hard loan” must be repaid in the immediate future, or the lender is likely to take legal action.
A classic example of a “closed loan” is a mortgage from a bank secured against the family home.
A mortgage must be paid off as a priority when the house is sold, so the amount owed will be deducted from the equity in that property to determine the equity available for distribution between the spouses.
What is a subsidized loan?
In contrast, a “low rate loan” is a loan that does not have to be repaid immediately or, in some cases, not at all. The loan may not have a specified repayment date, or may require payment of interest. Loans from family members often fall into this category.
The repayment of a “low rate loan” is considered at the discretion of the beneficiary and therefore will not generally be a priority in a divorce settlement.
The funds loaned are unlikely to be used for repayment; instead, available assets will first be distributed to meet the needs of divorced spouses.
How does a court decide if a family loan is “hard” or “soft”?
It is up to the party invoking the existence of liability to prove it. The court will consider all the evidence – which may include narrative statements and oral evidence from the lender and recipient, and any documentation proving the agreement at the time it was entered into – and determine whether the transfer of funds was a “hard loan.” “, A” subsidized loan “, or a simple gift.
The court will also consider the impact on the lender if the loan is not repaid and whether the needs of the spouses can still be met if so.
So, if you are planning to lend a large amount of money to a family member, how do you maximize the likelihood that the loan will be paid off in the event of a divorce?
How to get a family loan
- Establish a contract
At the time of the loan, the loan must be formalized in a loan agreement drawn up by a professional.
This agreement should clearly state the amount of money loaned, the parties to the loan (by whom and to whom the money is loaned), the purpose of the loan, and the intentions of the parties as to how, when and on what terms, loan must be repaid.
- Charge interest
While it is not strictly necessary to charge interest on the loan, this is a clear way to establish that the loan is a genuine business deal rather than just a gift.
Please note that any interest payment received is taxable income and must be declared to HMRC.
- Set a repayment date
It is strongly advised that the loan agreement specifies either a repayment schedule (for example, regular monthly payments) or provides for the repayment of the sum on a specific date or upon the occurrence of a particular event.
This event may be the settlement of a financial recourse procedure. It’s a good idea to have a repayment schedule in place – if there is a history of repayments made prior to the divorce proceeding, this signals to the court that repayments are actually expected and required.
The agreement should also provide for the consequences of non-repayment – for example, a punitive interest rate.
- Save it
Any loan contract can be executed as a deed. If an agreement is contained in a deed, then consideration is not required, so this can be a good course if you decide not to charge interest.
While this does not guarantee that the loan will be recognized as a hard loan, it does go some way in formalizing the agreement and demonstrating your intention to enforce it. Professional advice should be sought in the drafting and execution of the document as an act.
If the loan is used to finance the purchase of a property, the loan must be registered in the land register as a secured legal charge against the property.
With a legal charge on the property, such as with a mortgage from a bank, the loan must be repaid when the property is sold. This is the most effective way to ensure that your loan is protected in the event of a divorce.
- Keep records
Any transfer of money under the terms of the agreement – whether it is the initial advance or any reimbursement – must be made in such a way that records can be kept and produced later. A bank transfer is the easiest way to do this. Cash payments should be avoided.
In short, if there is no way to guarantee that a divorce settlement will provide for the repayment of a loan – the court retains absolute discretion as to the division of the property of the spouses – if you follow this advice, you are much more likely to prove the loan is genuine if the problem ever arises!
While it might seem awkward to suggest these formalities when a family member has come to you for financial assistance, having an open conversation and putting the right formalities in place early on can avoid costly and emotionally charged litigation.
Clarissa Wigoder is a lawyer at 4PB