Lending to family: why informal arrangements can create serious risks

With rising property prices and tighter lending conditions, many Australians are increasingly turning to the "bank of mum and dad" (and other family members) to assist with property purchases, business funding or short-term liquidity needs.

These arrangements are often made informally and with the best of intentions. But when family lending is not structured carefully, it can expose both lenders and borrowers to unexpected legal, commercial and personal risks - particularly if circumstances change.

From a legal perspective, loans between family members should be approached with the same discipline as arm's length financing. Clear documentation, enforceable terms and (where appropriate) security play an important role in protecting all parties and avoiding disputes down the track.

Gift or loan? Why the distinction matters

One of the most common issues we see in family funding arrangements is uncertainty about whether money was intended to be a gift or a loan.

In family law proceedings, the Federal Circuit and Family Court of Australia has wide discretion to characterise funds as gifts or loans. There is also a longstanding presumption, particularly in parent child relationships, that funds advanced without clear documentation are intended as a gift (often referred to as the "presumption of advancement").

Without proper documentation and evidence of a genuine creditor-debtor relationship, borrowers may find that what they understood to be a loan is treated as a gift from their spouse's family which may affect property settlement outcomes.

Courts consistently focus both on the parties' intention at the time the funds are advanced, and the manner in which parties have acted afterwards. Without contemporaneous evidence, such as a written loan agreement, a clear repayment history or steps taken to enforce payment, funds are more likely to be treated as a gift, even if the parties later describe the arrangement differently. Funds being treated as a gift may mean, in practical terms, that the party does not receive "dollar for dollar" credit for that gift, particularly in family law proceedings, effectively resulting in the other party then receiving some proportion of the funds advanced.

This risks of deferring documentation

Family loans frequently become problematic not because of bad faith, but because of changing circumstances. Common trigger events include:

• relationship breakdowns or family law proceedings
• borrower insolvency or bankruptcy
• death or incapacity of the lender or borrower
• refinancing or sale of property used as security
• disputes between siblings or beneficiaries in estate administrations.

These triggers are often unexpected, and attempting to retroactively characterise or document the arrangement as a loan is unlikely to be effective once they have occurred.

Structuring a family loan: a banking perspective

A handshake deal can quickly unravel if memories differ or circumstances change. Clearly documenting the loan terms helps avoid misunderstandings, supports enforceability if things go wrong, and is often critical evidence for tax, estate or insolvency purposes. A properly executed loan agreement protects both the lender and the borrower and helps preserve the family relationship by setting clear expectations from the outset.

From a lender and borrower standpoint, a family loan should be structured to reflect a genuine credit transaction.

A formal loan agreement

The loan should be documented in writing. The agreement should clearly set out:

• the principal amount
• repayment terms (including the loan term, instalment amounts and frequency, or whether the loan is repayable on demand)
• interest (if applicable), including the rate and how it will be calculated
• events of default
• enforcement rights.

Even where loans are interest free or repayable on flexible terms, documenting the arrangement clearly at the outset is critical.

While many family loans are structured as interest-free, there are reasons why parties may wish to include an interest component. Charging interest can help establish that the arrangement is a genuine loan rather than a gift.

Family loans can have tax and accounting implications for both lenders and borrowers (including with respect to Centrelink payments). Specific advice should be sought in this respect.

The role of security

Depending on the size and purpose of the loan, lenders may wish to take security, such as:

• a registered mortgage over real property (noting that second-ranking mortgages require careful consideration of priority)
• a general security deed over personal property
• guarantees from related parties.

Security not only strengthens enforceability but can also be critical in priority disputes with other creditors. However, family member lenders must be prepared to take enforcement action if required - failing to do so can undermine the characterisation of the arrangement as a genuine loan.

Where a family loan sits alongside existing or anticipated third-party debt (such as a bank mortgage), careful thought must be given to priority. Institutional lenders will typically require family loans to be subordinated to their facilities, meaning the family lender agrees not to receive repayment or enforce security until the senior debt is repaid. Family loans can also have the inadvertent result of affecting the borrower's borrowing capacity in the eyes of an institutional lender.

Subordination arrangements should be documented in a formal deed of priority or intercreditor agreement. Failure to address priority can result in the family lender's security being ineffective or their debt being repaid only after all other creditors.

Consistency counts

Representations made to banks, accountants, financiers or government bodies should align with the treatment of the funds as a loan. Inconsistencies can significantly undermine enforceability. It is not unusual, particularly in family law proceedings, for assertions as to funds being a loan being rejected, where the parties have confirmed in writing (often to the bank) that the funds are a gift.

Ongoing conduct matters

Courts and insolvency practitioners will closely examine whether the parties' conduct aligns with the documented terms and reflects a creditor-debtor relationship.

Regular repayments (even if modest), interest accrual and enforcement action (if required) all support the existence of a genuine loan. It is important to keep contemporaneous records of loan drawdowns, interest, repayment requests, actual repayments received, and any agreed amendments to the arrangement.

Risks for lenders and borrowers

For lenders, poorly documented loans may:

• be unenforceable (whether due to lack of evidence, limitation periods, or failure to comply with formalities)
• be subordinated or postponed behind external creditors (particularly where the family loan is unsecured or improperly perfected)
• be excluded from asset pools in insolvency or family law contexts
• create complications in estate administration, particularly where the loan is not documented or is inconsistent with the lender's will.

For borrowers, unclear arrangements can:

• complicate refinancing or property sales
• trigger disputes with spouses or business partners
• result in unexpected repayment demands.

Practical guidance for families

While family loans are inherently personal, they should still be treated as commercial transactions. In practice, this means:

• documenting the arrangement in writing at the time funds are advanced (not retrospectively)
• ensuring the structure reflects the parties' true intentions
• considering whether security is appropriate and understanding and addressing priority issues where other debt exists
• reviewing the arrangement periodically and as circumstances change (including if the borrower takes on additional debt or the property is refinanced.

Importantly, formalising a loan does not preclude flexibility. Loans can later be varied, forgiven or restructured with appropriate advice.

How we can assist

Our Banking & Finance and Family & Relationship Law teams regularly advises families on the structuring, documentation and enforcement of intra family lending arrangements. We work with both lenders and borrowers to ensure that family loans are legally robust, commercially sensible and aligned with broader financial and estate planning objectives.

If you are considering lending to, or borrowing from, a family member, early legal advice can help protect both your interests and your relationships.