Once again, the Bank of Mum and Dad is making headlines. As property prices enjoy a post-pandemic resurgence, an increasing number of first home buyers are being priced out of the market.
While a boon for homeowners, it’s a different story for those trying to get a foot onto the property ladder. According to recent analysis by Digital Finance Analytics (DFA), the Bank of Mum and Dad is now ranked as Australia’s ninth largest mortgage lender, lending adult children an average of $89,000…lending that’s increased approximately 20% over the past 12-months.
How do parents fund the Bank of Mum and Dad and what are the potential repercussions?
Traditionally, the Bank of Mum and Dad has relied on one of the following strategies:
- Parents raid their retirement savings or other nest eggs, which can negatively impact their retirement plans.
- Parents act as a mortgage co-borrower, which means they’re liable for any repayments missed by their child.
- Parents act as guarantor on the mortgage, which can constrain their ability to borrow and may put their property at risk if their child defaults on mortgage repayments.
Mum and dad give their daughter, Joanne $400,000 to buy a house. She then marries Ken. Ten years later Joanne and Ken divorce. The house is still worth $400,000. It is the only asset of the marriage. The Family Court awards $200,000 to Ken. The Family Court is not interested that the money was a gift from Joanne’s mum and dad. Instead, loans to children are safer.
Mum and dad lend $400,000 to their daughter, Joanne. Joanne signs a legally prepared Loan Agreement. Joanne purchases a house with the money. She marries Ken. Ten years later they divorce. The house is still worth $400,000. It is the only asset. The Family Court is shown the Loan Agreement. The Family Court orders that Ken gets nothing. This is because the assets of the marriage are nil.
But I love my children
There is nothing wrong with helping our children financially. It could be for their first car, grandchildren’s school fees, a holiday, or a property. Today it is becoming more popular to help our children with a home deposit, but simply giving away the money has real risks. It is important to protect the money in case:
- they divorce
- go bankrupt
- suffer from drugs
- suffer a mental condition
- stop loving you – ‘King Lear’ offers his daughters his Kingdom for the return of their love, but after they promptly abandon him
- you run out of money yourself, in your old age
Documenting loans to children
Never ‘give’ your children money. Always ‘lend’ them money ‘payable on demand’. Get it back if something goes wrong. Treat yourself like you are a bank, and your children are taking out a loan.
Creating a loan agreement not only protects your interests but also benefits the child as you can decide in the future to forgive the loan while you are alive or in your Will.
With loans to children, never rely on a verbal agreement, get a legally binding loan agreement.
Any tax issues?
There are no tax issues. The interest rate for the loan is ‘as advised by the Lender’. Therefore, while the interest rate is zero you have no income tax issues. If the child separates you can increase the interest rate to draw more money out of the failed relationship. There is less money for the Family Court to give to your ex-in-law.
At different times, it is common to benefit one child over another with money. If you benefit one child over another then it is adjusted automatically at the time of your death. Say you lend one child $500,000 and the other child $300.000 then that is adjusted at your death. So, it is all fair again.
When making loans to children:
- talk with all your children together about the loans
- never gift children money – only loan them money (this protects both you and them).
- don’t rely on home-made loans or IOUs – build a Loan Agreement
What happens if your child has a partner and buys a home?
What if your child has a partner? The loan agreement may change depending on whose name the home is purchased under. Best that your child signs the Loan Agreement and buys the home just in their name. This binds your child alone, and the partner has no say in the matter. What if the partner objects? It is important to stay firm and explain it is ‘to protect your interests, it is nothing personal’. This protects yourself and your child if the relationship with the partner does not end up ‘happily ever after’.
What happens if the home is purchased in both your child’s and their partner’s name? Then both your child and their partner sign the Loan Agreement. The Loan Agreements should allow the loan to be lodged as a caveat or registered as a second mortgage – but the bank is notified. So, caveats are more common.
Prosperity Accountants can assist you in preparing legally binding Loan Agreements.