Lending Money to Family and Friends: When Interest Becomes Taxable

Why Informal Loans and Tax Are Not Two Separate Worlds

Most people who lend a few thousand pounds to a sibling, adult child, or close friend never think about HMRC. The arrangement feels entirely private: money moves between bank accounts, perhaps a verbal promise is made, and that is that. But the moment you charge interest — even a modest 3% or 4% to reflect what you would have earned in a savings account — you have created a taxable income stream that HMRC expects you to declare.

The rules are not designed to punish generosity. They exist because without them, well-off individuals could lend large sums at high rates within their family and pocket the interest quietly. Understanding where the lines are drawn lets you structure any informal loan in a way that is both honest and efficient.

How HMRC Treats Interest on Private Loans

HMRC treats interest you receive from a private loan just like interest from a savings account or a peer-to-peer lending platform. It is savings income, taxed after your Personal Savings Allowance (PSA) is used up.

For 2026/27 the PSA thresholds are:

So if you lend £20,000 to a friend at 5% and receive £1,000 in interest during the tax year, a basic-rate taxpayer would pay no tax at all — the PSA covers it exactly. A higher-rate taxpayer in the same situation would have £500 within the allowance and owe 40% on the remaining £500, which is £200.

If you already have significant savings interest elsewhere — from a cash ISA ladder, premium bonds prizes counted differently, or fixed-rate bonds — remember that all savings income pools together against a single PSA.

What Happens If You Charge No Interest

Charging zero interest on a personal loan removes the income tax problem entirely. There is no deemed interest under UK law for ordinary loans between individuals, meaning HMRC will not invent a fictional return and tax you on something you never received.

The main exception involves married couples and civil partners. If one partner lends a large sum interest-free to the other, who then invests it to generate income, the settlement legislation (Chapter 5, Part 5 of ITTOIA 2005) can step in. HMRC may treat the investment income as still belonging to the lending partner, defeating the purpose of any income-splitting arrangement. This is a specialist area — if you are thinking about large sums and income shifting, take professional advice before proceeding.

For loans between parents and adult children, siblings, or unrelated friends, zero-interest arrangements are generally straightforward. The borrower pays back the capital over time, no interest changes hands, and there is no income to report.

The Gift Trap: When a Loan Becomes a Gift

Writing off a loan — whether through a formal deed or simply by never chasing repayment — can have Inheritance Tax consequences. HMRC looks at substance, not just labels. If you lend £50,000 to your child and then decide five years later you never want it back, you have arguably made a potentially exempt transfer (PET) at the point of write-off.

For 2026/27 the Inheritance Tax nil-rate band (NRB) is £325,000, and if you own a qualifying residence that passes to direct descendants, the Residence Nil-Rate Band (RNRB) adds a further £175,000, for a combined £500,000 threshold before the 40% rate applies. Gifts above your annual £3,000 exemption start a seven-year clock; if you die within seven years, taper relief may reduce but not eliminate the charge.

The practical lesson: if you genuinely intend the arrangement to be a loan, keep a written record and make some repayments — even token ones — to demonstrate the loan's reality. A loan that looks like a loan from day one is far less likely to be recharacterised as a gift.

Documenting the Arrangement: What to Put in Writing

A simple typed and signed loan agreement does not need to be drafted by a solicitor, although for larger sums that is worth considering. At minimum, record:

• Names and addresses of lender and borrower
• Loan amount and the date it was advanced
• Repayment schedule — even a flexible one (e.g. "repaid in full by 31 December 2030, or on demand")
• Interest rate, or an explicit statement that the loan is interest-free
• What happens on death of either party — does the debt form part of the estate?

Both parties should sign and keep a copy. If you later apply for a mortgage or benefit, a well-documented loan arrangement also helps a borrower demonstrate that a large deposit is genuinely repayable debt rather than undeclared income.

Declaring Interest: Self Assessment and Beyond

If you receive taxable interest on a private loan, you need to tell HMRC. The route depends on your situation:

Already registered for Self Assessment: Include the gross interest figure in the savings income section of your return. Keep bank statements or a loan repayment ledger showing exactly how much was paid.

Not registered for Self Assessment: If total savings income (including loan interest) pushes you over your PSA, contact HMRC. For amounts under around £10,000, HMRC can often adjust your PAYE tax code to collect the extra tax through your wages or pension without requiring a full return.

Sole traders and the self-employed: If you are already filing a Self Assessment return for business income, adding loan interest is simply a matter of completing the savings section — it does not create a separate filing obligation.

Using the

calculator can help you estimate how much tax, if any, you might owe on interest received from private loans alongside any other savings income.

Capital Repayments Are Not Income

One source of confusion is the difference between repayments of capital and repayments of interest. If you lend £10,000 and receive £10,000 back, you have received nothing taxable — you simply got your money back. Only the interest element is income. If the borrower pays you £500 per month and the loan carries 4% interest, you need to identify what portion of each payment is interest and what portion is capital reduction, using standard amortisation principles.

For simple arrangements, a spreadsheet or an online amortisation calculator is perfectly adequate. The important thing is to be consistent and to keep a record, so that if HMRC asks you can demonstrate exactly how much interest you received in any given tax year.

Larger Loans and Stamp Duty Reserve Tax

Some people wonder whether a private loan could ever attract Stamp Duty Reserve Tax (SDRT) or Stamp Duty Land Tax (SDLT). In practice, a cash loan between individuals does not create a land transaction and does not involve the transfer of shares, so neither SDLT nor SDRT applies. However, if a loan is secured by a legal charge on property (a private mortgage), the documentation might attract a nominal stamp duty charge — another reason to seek legal advice for large, secured arrangements.

Practical Scenarios

Scenario 1 — Interest-bearing loan, small amounts. You lend your brother £5,000 at 3% while he saves for a deposit. He pays you £150 in interest over the year. You are a basic-rate taxpayer with £800 of interest already from your savings account. Total savings income: £950 — still under your £1,000 PSA. No tax to pay, no declaration needed beyond checking the position.

Scenario 2 — Higher-rate taxpayer, larger loan. You are a higher-rate taxpayer earning £60,000. You lend a friend £30,000 at 4%, generating £1,200 in interest. Your PSA is £500. The taxable amount is £700 (£1,200 minus £500), taxed at 40% = £280 extra tax. You must report this via Self Assessment or ask HMRC to adjust your tax code.

Scenario 3 — Interest-free loan written off. You lend your adult daughter £40,000 interest-free to help buy a flat. Three years later you decide to write it off. The £40,000 becomes a gift — a PET. If you die within seven years, and your estate is large enough, it may attract IHT at 40% on amounts above your NRB. No income tax issue, but potentially a significant IHT one.

Use the

calculator to check your overall income tax position, and the tool to see how private loan interest stacks up against your allowances.

Summary: Keeping It Simple and Compliant

Lending money to people you care about is a genuinely kind act. The tax system does not penalise it — but it does require honesty about any income generated. The headline rules for 2026/27 are straightforward:

• No interest charged means no income tax issue (with the spousal settlement caveat for very large amounts).
• Interest charged is savings income, sheltered by your PSA (£1,000 basic rate, £500 higher rate, nil additional rate).
• Written agreements protect you against HMRC treating a loan as a gift.
• Writing off a loan starts a seven-year IHT clock.

For anything beyond a modest amount, or where the family dynamics are complicated, a conversation with a qualified tax adviser is money well spent.

---

This article is for information only and does not constitute financial or tax advice. Tax rules may change. Consult a qualified adviser for your specific situation.