As parents you want to help your kids. But emotional lending to family members could be a recipe for disaster, especially if you put your own financial position on the line. Taking stock and giving careful, rational consideration to the lending circumstances is crucial as you step into a Bank of Mum and Dad (BoMaD) role.
Knowing the difference between gifting and lending and understanding the importance of loan agreements, asset protection and estate planning are the keys to preserving your family’s legacy and making sound family decisions.
It’s normal for parents to want to provide financial help for their adult children, especially if they’ve not been able to save a sufficient deposit or secure funding for themselves.
You may be interested to know parents are now lending their kids an average of $90,000 for home loan deposits [1]. The BoMaD is now collectively worth about $35 billion, and it’s recognised as Australia’s nineth largest mortgage lender.
When making decisions about lending to family members, it is important to take a lender’s perspective and convey this to your children. They need to understand that your lending decision is significant and more than just good old mum and dad coming to the rescue.
Affordability in context of your stage of life, is the first (and obvious) consideration.
As much as you may want to help your children, it is important to cover your own financial needs first. The average life span in Australia is just shy of 84 years, however our own financial planning modelling is based on a longer period of time, as people are generally living longer and require a particular lifestyle.
A loan or gift will impact your financial outcome and needs to be understood.
When it comes to money you can ‘gift’ it or ‘loan’ to your children. You can also ‘go guarantor’ on a loan. With each of these scenarios there are important considerations you need to understand.
Going guarantor
May we caution you to think long and hard before guaranteeing any finance arrangement. Helping your kids to qualify for a loan on a significant purchase is one thing, putting your own financial well-being at risk is quite another.
This decision should be considered in context of asset protection. The reason you are being asked to back the loan will most likely be because the lender is not confident in your child’s ability to service the repayments on what is commonly a 30-year term. Should your child default on repayment, you will be required to foot the bill and this could cause financial hardship that could threaten your livelihood and put your assets at risk. In a guarantor scenario, you won’t be the owner of the asset (i.e. it’s your child’s home) which can make things even more complex, particularly if they are in a relationship with a spouse or de facto partner.
Gifting
A more appropriate option may be to gift or loan your child money. However, it must also be said, this approach has risks as well.
For example, there have been many well-intentioned parents who have gifted a substantial amount of money to an adult child and their spouse for the purpose of financing a family home, then the relationship breaks down. The home is sold and the proceeds from the sale are more than likely subject to family law provisions, whereby a large portion of the proceeds are split with your child’s now ex-spouse. This means a potentially significant amount of money would be ‘lost’ from your family’s legacy.
Lending
Had the money been loaned to the adult child and their spouse for the same purpose, it could have been formalised in a loan agreement with clauses and conditions outlining instructions for repayments.
For parent lenders, who recognise the realities of relationships in life, or do not feel confident about the future of their child’s relationship, this is a particularly attractive strategy. This is also a strategy which may be appropriate for those who have children who own businesses or work in a highly litigious environment.
Parents are also concerned about fairness when helping children. Lending with an associated loan agreement can help to ease these concerns, as greater clarity and understanding can be obtained by all family members.
Importantly, any loan agreement should be formally documented by a solicitor both for reasons of clarity and asset protection.
A formal loan agreement should include security, which typically is taken in the form of a mortgage (potentially a second mortgage if a bank has the first mortgage) over the property. This will in part, protect your financial interest which may be the deposit amount of a larger loan provided by another lender.
As your solicitor will no doubt advise, it is critical that the security over the loan is registered at the same time as formalising the loan agreement. This is to ensure your financial interest in the loan is known along with other creditors.
In the event of a relationship breakdown or a creditor trying to sue your child, you as the lender will have the ability to ‘call in’ your loan. This may reduce the asset pool available under the family law provisions or reduce assets available to creditors, which can also help preserve your family’s financial legacy.
Estate Planning
Some parents consider lending to family members an opportunity for their child to access their inheritance early. While some parents may not require repayments, others do, with consideration to then ‘forgive’ the loan once they pass away.
All this needs to be documented in your Will and estate plan to create financial clarity for the loan recipients while addressing financial fairness for other family members and beneficiaries who may not have enjoyed loaned or gifted family money.
Next steps
Lending to family members requires careful consideration, and as always, we strongly urge you to get financial and legal advice before you make any financial commitments.
Apart from the very practical matters of addressing affordability and asset protection, you may also benefit from an arms-length discussion about the often-emotional ramifications of family money and fairness as your money decisions will affect all your children.
As you’ve read here, there are many family lending matters you need to know about and discuss with your children. These discussions can be difficult as emotional and financial complexities interplay, however, you’ll be pleased to know we are experienced at facilitating these types of discussions.
To learn more, and if appropriate to organise a family discussion about lending and other family money matters, please contact Brett Cribb, Steve Nicholas or James Marshall on +61 (0)7 3007 2007, alternatively please email info@stratusfinancialgroup.com.au, and let’s make it happen.
Stratus Financial Group helps professionals, executives, business owners, families and retirees manage their complex financial affairs and coordinate their professional advisers.
Stratus Financial Group and its advisers are Authorised Representatives of Fortnum Private Wealth Ltd ABN 54 139 889 535 AFSL 357306. This is general advice only and does not take into account your objectives, financial situation or needs, so you should consider whether the advice is relevant to your personal circumstances. You should also read the relevant Product Disclosure Statements (PDS) before making any financial decisions.
Further reading:
Living Financial Legacies: Giving to X and Y Gen with a warm hand
