We have written before about the “Bank of Mum and Dad” which is a colloquial expression referring to parents (or grandparents) providing financial support to adult children, often to help them to make a start to get on to the property ladder. Such support can come in various forms including gifts of money, loans or parents acting as guarantors on children’s mortgages.
In many countries including Australia, the “Bank of Mum and Dad” has become one of the largest lenders for first time buyers. As property prices in Australia have soared, so too has the difficulty for young people to enter the property market without assistance. Estimates suggest that something like two in five potential borrowers aged between 25 to 34, expect to ask their parents for financial assistance to enter the property market.
Whilst the “Bank of Mum and Dad” can provide significant benefits to children, it can also cause detriment to “Mum and Dad”. Parents need to be aware of their own financial needs and security including potential aged care requirements and pension entitlements if funds are gifted to children. Children as borrowers should also be aware that a gift from parents to help them raise a deposit to satisfy a commercial bank lender may actually reduce the children’s own borrowing power.
As previously discussed, if money is given by parents to a child and/or their spouse as an outright gift, it risks being included in the children’s matrimonial asset pool in the event of a matrimonial or de facto relationship breakdown. If money is advanced to children as a loan, whilst it may protect funds from matrimonial breakdown, it will also have the effect of itself reducing the children’s borrowing capacity as the banks will take into account the servicing by the children of the loan to the parents when assessing the ability of children to service a further bank loan. There is an obvious trade-off.
In comparative terms, a young couple with a joint household income of $250,000 without any other debts or other dependents, may have a borrowing capacity of up to $1,300,000. If a loan from the “Bank of Mum and Dad” in the amount of say $200,000 was established to assist with a deposit, the borrowing capacity of that couple may be reduced to around $820,000, taking into account a commercial bank’s normal lending and serviceability criteria. There is an inherent trade-off between parents wanting to protect funds advanced to children versus assisting children to obtain finance.
The trade-off is even more clear when one considers that parents and children “can’t have it both ways”.
In the family law jurisdiction, parties who may have established formal loan arrangements with parents can seek to rely upon such documents evidencing the loan in order to protect funds advanced by parents. Any such formal loan will again affect the children’s borrowing capacity. Children who represent to a bank that an advance by parents is a gift will generally be required by the banks to sign a statutory declaration declaring that the gift is non-repayable. In those circumstances, it cannot also be a loan, and it will not be possible to have the gift protected from matrimonial property proceedings as forming part of the pool of matrimonial assets. In light of that trade-off, what is the best option?
Many parents are encouraging their children to enter into binding financial agreements. To be binding (and essentially worth the paper that they are written on) various formalities are required regarding the agreement in both substance and procedurally which must be adhered to pursuant to the Family Law Act.
Many more parents will require such an agreement being entered into by their children as a condition of lending funds.
Other options might include, as reflected above, parents going guarantor for children whereby they can use their own home as mortgage security or even parents helping to service the loan on a regular basis rather than parting with lump sums.
Gift or loan? It’s complicated, you should seek specialist advice. Feel free to call one of our lawyers on 08 8344 6422.