How are loans from friends and family members treated upon divorce?

It is increasingly common for people to receive help from parents or other family members to buy their first homes, or even pay off an existing mortgage. Gifting money to buy property in this way can be tax-efficient and economically sound for the whole family. However, where the property owner then finds themselves going through a divorce, the status of these funds - whether they are a gift or a loan - can become a topic of debate. Why does this matter? 

If a money is treated as a gift, it will form part of the matrimonial pot available to be split between the parties and used to meet their needs. If the money transfer is treated as a loan – and in particular a “hard” loan - it cannot be considered part of the matrimonial pot and will instead be noted as a liability or debt which needs to be repaid.  

But how do you know whether money transferred between family members is a loan or a gift? Or whether the loan is “hard” or “soft”? One party may say that a financial contribution towards the purchase of the family home made by parents years ago must be repaid whilst the other argues that it was never expected that these monies would be repaid. 

The key question is: what is the likelihood that the obligation to repay will be enforced? There is an expectation with a loan that it will be repaid and the lender could enforce repayment.  By contrast, a gift tends to be more informal with no expectation of the money being repaid at a later date. 

The court has recently set out a non-exhaustive list of factors to consider when dealing with financial contributions from friends or family which help us to work out whether we are dealing with a gift or a loan. 

Factors which suggest a gift include:

• there is evidence of an intention to give;
• there are no strings attached to the money transfer; and
• there is no expectation that it will be repaid in the future

Gifts will form part of the matrimonial pot available for division between the parties. If you cannot prove that the payment is a gift, the payment is considered to be a loan. The next question is whether it is a “hard” or “soft” loan.

Factors which suggest a hard loan include:

• the obligation is to a finance company;
• the terms have the feel of a normal commercial arrangement;
• there is a written agreement;
• steps have been taken to enforce repayment;
• there has been no delay in enforcing the obligation; and/or
• amount of money involved means the lender is likely to expect repayment.

Hard loans, in contrast to gifts and soft loans, are treated as a liability of one or both of the parties which need to be repaid and so will be factored into any final divorce settlement.

Factors which suggest a soft loan include:

• the lender is a friend or family member who is on good terms with the borrower and is unlikely to want them to suffer hardship; 
• the obligation arose informally and the terms do not have the feel of a normal commercial arrangement;
• no steps have been taken to enforce repayment despite the due date passing;
• there has been a delay in enforcing the obligation; and/or
• the amount of money involved means the lender is more likely to waive repayment.

The courts tend to view soft loans as never to be repaid in the future and so won’t always take them into account when deciding a settlement.

This is a reminder that loans made to one’s nearest and dearest or received from them will be scrutinised within a divorce. For advice on how to ensure that such financial contributions are protected where there is an expectation that they be repaid, or if there is a disagreement between you and your partner about sums one of you has received from a friend or family member, please contact the family team.