Lending to family members and friends can seem like a good idea at the time. But if there's a misunderstanding about the terms of the loan there can be breakdowns in relationships with those whom you care most about.
It seems there are a lot more informal loans between family members and friends than is usually appreciated. Research by the Commonwealth Bank released in 2012 estimates Australians borrow $1.6 billion a month from family and friends.
The Commonwealth Bank's numbers showed that from among informal lenders, the "Bank of Mum" firmly tops the list as the preferred source of funds. Children are more likely to ask their mums than their dads for a loan.
Most of these loans are undocumented, which increases the likelihood of disagreements and breakdowns in close relationships.
Phil Hopper has borrowed money from his parents to use for his business, which brands fleets of cars, trucks and trailers with signage. He's also lent money to his children over the years.
In the past he has used a spreadsheet to keep track, which he admits can be a little "ad hoc".
The 44-year-old Sydneysider is now using a new online tool called Credi, which turns informal agreements into manageable and formal ones that are stored online.
He receives reminders that repayments are due. Credi helps keep track of the loan and if there is ever disagreement over the amount of interest or other terms of the loan, the agreement is readily available to both parties.
"I could get a loan contract together with a lawyer for a healthy fee, but the real value to me is that I can go to one spot and find it all there," Hopper says.
With Credi, which is believed to be the first product of its type, lenders and borrowers negotiate the terms of the loan, agree and sign it electronically.
There is a legally binding record of loan agreements and repayments. Reminders are sent to the borrower that repayment is due and the lender is notified when the repayment has been made.
Credi is free to the public for loans under $10 million and will stay free, other than for advanced options that may be offered in the future.
Tim Dean, the founder of Credi, says parents are sometimes happy to give money but want to structure it as a loan to give their children some life lessons.
"We want to educate them about money and meeting their obligations but we probably want to let them off [repayments of the loan] after they have shown you that they are taking their financial responsibilities seriously," Dean says. "That's what happens with my kids."
With Credi, lenders can choose to send a notification to the borrower to forgive the remaining debt.
People often don't formalise their agreements or they email or call to communicate their wishes, which can lead to misunderstandings.
At best, many people simply download a loan template document that they pass between themselves, but documentation is often not understood or properly completed.
Ian Macleod, from RP Emery & Associates, a publisher of legal documents, says lending to family and friends is risky without proper documentation.
"The reality is most people enter into these loan arrangements on a hug and a handshake, but the terms and conditions are often unspoken or inferred," Macleod says.
"A verbal contract is binding on the parties, but without a written agreement the parties will find it difficult to prove the terms of that contract."
Laura Menschik???, a financial planner and director of WLM Financial Services, says if it is parents lending money to their children it is important that the loan be noted with their estate planning documents to avoid any disputes with siblings over who gets what if the parent should die before the loan is repaid.
Michael Harris, a senior associate, commercial litigation at Slater and Gordon, says if it is a loan and not a gift it definitely should be documented.
"Otherwise, if there's a dispute, the borrower will sometimes say it was a gift," he says.
Harris knows of cases where a loan was made by a parent to an adult child and their partner to help buy a property. The couple splits up, the house is sold and the partner takes half of the proceeds of the sale of the house, leaving the lender's son or daughter to repay the debt.
Harris says that's why it's important for the lender to have some security over the property.
"The security on the loan can be just as important as the documentation," he says.
For real estate, an interest called a "caveat" can be lodged with the lands and titles office of the state or territory in which the real estate is located. The caveat alerts a potential buyer of the property that someone else has an interest in the property.
However, that can only happen if the loan agreement contains a clause that specifically allows the lender to lodge a caveat over the property.
Menschik says it is particularly important to document financial agreements when the loan is for a business purpose.
"That's especially for larger loans and even more so when the loan is for someone to start a new enterprise, such as a business or purchasing a vehicle to earn income, for example."
Menschik says the risks of lending for a business are much greater than lending to someone to put a deposit on a house.
"I have seen parents made almost bankrupt because they wanted to help their children and their children's businesses have failed," Menschik says. "When lending for a business there is usually no collateral and while property can go down in value at least there is collateral."
Like with caveats over property, lenders can register a "chargeable interest" over an item of property, such as a motor vehicle, whether for business or personal use. That is an obligation, restriction or condition on the sale of the good.
An interest in a motor vehicle, for example, can be registered on the Australian Government's Personal Property Securities Register and noted in the loan agreement.
Harris says if the loan is to help a friend or family member with a business start-up, the loan agreement could specify that the lender receives equity in the business rather than cash, for example.
Risks for guarantor
If a lender is not willing to give a loan to a person, it may ask for a guarantor.
Parents and friends should think carefully before guaranteeing a loan, WLM Financial Services financial planner and director Laura Menschik??? says.
It really means that you are a co-borrower. And, if the person for whom you are guarantor does not keep up their repayments the lender may come calling on the guarantor to repay the loan.
There can also be implications for the guarantor's credit record if something goes wrong, making it harder, or perhaps impossible, for the guarantor to obtain credit.
Menschik says it is better to only guarantee a part of the mortgage, up to a certain amount, where the guarantor would be able come up with the cash if required.
However, that is likely to be difficult for most parents given the size of the deposit needed for Sydney and Melbourne properties.
A recent survey of parents, conducted on behalf of Stockspot, finds less than one in three families could afford to lend or give more than $30,000 towards their children's first home.