Unaffordable housing leads to reliance on bank of mum and dad
As Australia continues to rank among the least affordable markets for housing globally, it is becoming increasingly difficult for young people and other aspiring first-home owners to buy a property. Consequently, the "bank of mum and dad" is as popular as ever.
However, there are risks that both parties should be aware of, as they can have very serious implications for family relationships and personal finances. Our lawyers share some of the horror stories they have encountered.
What is the "bank of mum and dad"?
The "bank of mum and dad" – sometimes referred to as BOMAD or the "bank of dad" – is a term used to describe family loans or other financial support provided by parents to adult children, typically to help them buy a property.
This support can take many forms, including providing a gifted deposit or acting as a guarantor for a mortgage.
While the bank of mum and dad can be a great way to help adult children, there are financial risks and legal implications which can have major consequences for the parents.
One of the biggest risks with lending or giving money is that the parents may not fully understand the implications of the financial support they are providing to their children.
Can you afford to subsidise your child's property purchase?
With inflation soaring and interest rates rising, the skyrocketing cost of living is having a real impact on family finances.
Parents may feel obliged to assist their children, even if they are no longer in a financial position to do so. As a result, they may dip into retirement savings or take out a loan, which may not be the best financial strategy for them.
You need to consider fully the impact that providing support will have on your own financial situation. You may underestimate the amount of money you will need in retirement, or may not consider the impact that your support will have on your own ability to obtain credit in the future.
Centrelink payments and age pension entitlements
If you are a recipient of Centrelink benefits, you need to be careful about the financial assistance path you choose, as there are rules around how much money an individual or couple can gift without Centrelink payments being affected.
Similarly, should you be nearing retirement age and wanting to gift a substantial amount of money, it might be wise to receive financial advice regarding the timing of such a gift, to ensure it does not impact your application for the age pension, or your estate.
It is important to consider the impact on your estate of providing financial assistance to your child, particularly if you have other children.
Dangers of acting as guarantor on a mortgage
Acting as a guarantor on a mortgage means agreeing to the responsibility for the mortgage repayments if your child is unable to make them. This means if your child misses any payments or defaults on the loan, you could be held liable for the outstanding balance.
This could have very serious financial consequences for you, including the need to incur legal fees, a potentially damaging credit score and a negative impact on your own finances.
In some cases, you could be required to put your own property up as security for the mortgage, which could put you at risk of losing your own home if your child defaults.
Implications for future borrowing capacity
Being a guarantor can also reduce your own borrowing capacity, as lenders will take into account the outstanding debt that is guaranteed when assessing your ability to borrow.
It is important to remember that being a guarantor can be a long-term commitment, which may end only when the mortgage is paid off, or your child takes over the responsibility. (For more information please see Getting independent legal advice before you go guarantor on someone's loan.)
All of these things can lead to strained family relationships and conflicts. This can include your other children feeling slighted if they do not receive the same support, or if you are forced to take over the loan repayments.
Avoid unlimited or open-ended loan guarantees
If you intend to go guarantor for your child, you should ensure a reasonable limit is placed on the guarantee. Do not leave it open-ended or unlimited and make sure the bank notifies you early of any defaults.
In deciding to go guarantor, you should also receive separate, independent legal advice, so that you are fully informed when you enter the arrangement – or choose not to pursue it.
Is the bank of mum and dad providing a loan or a gift?
Providing a loan or gifting money are two different ways a parent may provide financial assistance to their child.
A loan is an amount of money given with the expectation that it will be paid back, generally with interest. The borrower is legally obligated to repay the lender according to the terms of the agreement.
A gift, on the other hand, is a transfer of money or property without the expectation of repayment. You should be aware that if you provide assistance as a gift, you will typically have no control over how the money is ultimately used.
A loan will typically be documented with a contract outlining the terms of the agreement, such as the amount borrowed, who the parties to the loan are (ie the parents and the child), the interest rate, a repayment schedule and the consequences of default.
Consider a range of possible scenarios
Apart from the sale of the property, you should consider other events that could trigger a clawback of the funds. This could be vital, for example, if you suddenly need the money for a nursing home, another child or an emergency.
It is important to think about what will happen to the loan in different scenarios. For example, what happens if your child ends up selling the property? Will the loan be repaid to the you at that point, or does the loan get transferred to a new property?
What happens if your child's relationship breaks down?
A key question is what happens in the event of a marriage breakdown of the child who has been gifted or lent money. If the child is married or has a de facto, the financial support you have provided may be considered to be part of the marital assets and could be subject to division in a divorce or separation.
This is also one of the reasons we recommend you make the loan out to both property buyers – your child and their partner, not just your child. In the event of a relationship breakdown, this prevents the partner from being able to claim the money was a gift, not a loan.
Seek professional advice and document everything
Ultimately, most of the problems we see arising from the bank of mum and dad largely could have been avoided if proper documentation had been prepared from the outset.
It is highly recommended you seek independent financial and legal advice before gifting or lending money, to ensure all parties are protected.
You may find you will be advised to prepare documentation in the form of a Deed, have a mortgage to secure the debt, and ensure you have considered the financial impact on the other beneficiaries of your estate.
Not only does this ensure everyone is on the same page, but it can help avoid disputes between you and your child (and their partner), and between your children after your death.
After all, documents are much easier to enforce legally than verbal agreements.
Sort out documentation before advancing money
It is important to ensure that all documents are prepared in advance and that any mortgage is prepared before any funds are transferred.
If the documents are prepared after the money is advanced, there is a risk that the mortgage will be set aside in the event of insolvency or bankruptcy, as the security was given after the fact.
Case study #1 – Parents suddenly need the loan to be repaid
One of the pitfalls we see is parents not documenting a loan to their child, then realising they need the money – such as for nursing home accommodation if they suddenly become ill or incapacitated.
Sometimes "life happens" and events occur that were not anticipated. If the transfer of funds was not documented as a loan, with certain clawback options to recover the money, there is little you can do to get your money back.
You need to consider all scenarios and ensure these are incorporated into loan documentation.
Case study #2 – Adult son refuses to repay loan and demands equal share of estate
We have seen some sad family disputes arise from parents providing money to one child, and this having an impact on their other children. This often happens if the parents pass away before the loan is settled, or the arrangement disadvantages the other children financially.
In one matter, the parents gave money to an adult son, assuming it would be repaid. The loan was provided many years earlier and was undocumented.
When the parents passed away, they had divided their estate equally between their children.
The executors went to the child who had been lent money and asked him to repay it. However, he claimed the statute of limitations applied, due to the time that had elapsed since the money was lent.
He refused to repay anything and demanded his share of the estate.
Case study #3 – Pitfalls of going guarantor on someone's else's loan
Going guarantor can lead to very messy financial and relationship problems down the track, and we advise our clients to be very clear about the guarantee limit.
We had a phone call recently from a prospective client with questions about a couple who were separating. They had a $1.9 million mortgage, a loan-to-value ratio (LVR) of almost 70%, and monthly repayments of $10,000.
Hopefully there was no guarantee by the parents on that mortgage!
Case study #4 – Is it a loan or a gift?
An problem we often encounter is that financial assistance to a child has been provided informally, with parties trusting each other to "do the right thing".
Parents may have intended the money to be given as a loan and repaid. However, if this is not documented, it can be hard to prove.
Sometimes, when clients who are the parents come to us for advice, even they themselves aren't clear on whether they intended the money to be given as a loan or a gift. Generally, money given to family is considered to be a gift.
We advise clients that if they are expecting to be repaid, they should make sure the arrangement is thoroughly documented as a loan, with clear terms and a record of repayments.
Case study #5 – Failure to include child's partner in loan documentation
One of our clients sold their house overseas and gave their child and the child's partner $170,000 to put towards a property.
That relationship ended, and the ex-partner now claims the money was a gift, not a loan, and therefore is part of the marital assets.
Although the parents will get some of their funds back, they won't receive dollar for dollar. This is why we tell our clients to ensure the loan is to both property buyers, not just their own child.
Case study #6 – Falling-out between parents and child
We have seen sad situations where parents have lent their children money, but then there has been a falling-out between the parents and the child.
Generally in these situations, if a lot of money has been provided, the only solution may be for the child to refinance the house and buy out the parents. However, given today's property prices, this is not always a realistic financial option for the adult child.
If the financial arrangement is properly documented, it can help the parents to force the sale of the house to recover some of their money.
Case study #7 – Seek legal advice before you act
In a recent property matter, parents had built and paid for a granny flat on land purchased by their child.
They came to us to find out what interest they had in the land, as they wanted to formalise the arrangement, protect their investment of money and retain some title over the property.
Unfortunately, the answer was that they had no interest in the land at all. The property is owned by their child. The parents should have sought legal advice before proceeding, to ensure they were added to the title.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.