What happens with family loans and gifts in a divorce?
Nearly half of first-time home buyers in the UK now need extra funding from parents. Knowing how to protect and/or recover loans or contributions is really important if couples subsequently separate and divorce.
What is the difference between a loan and a gift?
It can sometimes be difficult to prove that money was in fact a loan rather than a gift. It is all too common during a divorce, for one party to claim that money from a member of their family was to be paid back, whereas the other party, argues the funds were gifted, and therefore form part of the pot of assets to be divided. To pre-empt this issue, it is essential for relatives to be very clear at the outset, about the basis on which money is given, whether for a home deposit or for anything else, since it will be treated differently in law depending on whether it is classed as a gift or a loan.
A gift must be given voluntarily with no benefit to the giver, and it should be clear that there was never an intention it should be returned or repaid. A loan on the other hand is treated as a liability and there is an obligation that it will be repaid in the future.
Parents, or other relatives looking to help out a family member, should be aware that an outright gift, be it money, jewellery, a car, property, or anything else, cannot be recovered by the giver in the event of their child’s divorce. If it is considered a gift to both parties treated as part of the matrimonial pot, which is divided up between the parties should they separate or divorce. Even if it is a gift to one party, the other could be entitled to share if it was invested in matrimonial assets, such as the matrimonial home. If the court took the view that the gifted asset was non-matrimonial, an advanced inheritance to one party, the court could still take into account as a resource that party has available to meet their needs, which in turn could effect how the matrimonial assets are divided.
There are various ways that the family money or asset can be protected
- A pre-nuptial agreement is one way of protecting a gift or money given before marriage.
- A post-nuptial agreement could be entered into to protect a gift received during the marriage.
- A loan agreement could record that money, such as a hefty house deposit, was intended to be a loan rather than a gift, and needs to be repaid to the donor, for example on sale of the house. However, it is important to consider that a loan, for example to someone for the purchase of a property, might influence how much they can borrow from a bank, or the terms of the mortgage offered.
- A Declaration of Trust or Legal Charge, a formal document which records the donor’s interest in a property, where they are contributing to the purchase price, but on the basis that the money is to revert to them.
How are gifts and loans considered when a marriage ends in divorce?
When a marriage or partnership ends, there is often a disagreement about how the finances and assets should be split. If money has been given to the couple from one side of the family, for example the husband’s parents, it is natural that he may want to argue that the money he received from his parents was a loan and that he has an obligation to repay it at some point. The wife, or ex-partner may, in turn, want to argue it was a gift and forms part of the matrimonial assets. How does the court determine this difference of opinion, whether it was a loan or a gift, and if the latter to whom it was given (was it a gift to the party related to the donor or to the couple jointly)?
The court would hear evidence from both parties and would look at all the circumstances and reach its own decision regarding whether or not the financial help should be classified as a gift or loan. However, this can involve expensive litigation for the divorcing couple involved. Sometimes, the donor will need to become involved in the proceedings, at least as a witness and other times being joined as a party to the case. This again can increase costs.
How does the court distinguish between hard and soft loans?
When money is lent to a close family member, or even a good friend, it is often provided on the understanding that there is no immediate rush for it to be repaid, no interest will accrue, nor are there any terms or conditions to the loan. Lawyers frequently refer to this type of loan as a ‘soft loan’. A ‘hard loan’ usually refers to a commercial loan, for example to a bank or building society, which will need to be repaid.
In court, when considering how the assets and finances should be divided in a financial proceeding, a judge may treat a soft loan as if it were a gift, assuming that it does not need to be repaid and therefore part of the assets available to the couple. A 2022 case provides a list of factors that the court will use to decide whether the loan is hard or soft.
Factors that point to a soft loan:
- The obligation is to a friend or close family member
- The loan is informal
- There has been no written demand for repayment
Factors that point towards a hard loan:
- The obligation is to a finance company such as a bank or credit card company
- The terms of the loan have the feel of a normal commercial arrangement
- There is a written agreement in place
- There is a written demand for payment
Conclusion
It is important to consider from the outset how any money provided from a family member should be treated. If it is intended to be a loan, it would be advisable to enter into a formal loan agreement so that, if necessary, it can be used to prove the money needs to be repaid. This ensures that all parties are on the same page and that there are unlikely to be hidden legal consequences down the track. It also means the funds will not form part of the matrimonial pot of assets to be divided between the parties. If there are third party interests that arise during a divorce, with a family member seeking repayment from the parties before their assets are divided, it is important that all parties seek legal advice as to how those funds will be treated.
If you or someone you know wants more information or needs help or advice, please contact us on 01785 336617 or email [email protected].