Law Talks Episode: The bank of mum and dad – financial gifts and inter-family loans

Robyn: Good morning and welcome to 4CRB’s Law Talks. Today, we welcome back to the studio Attwood Marshall Lawyers’ Family Law Associate, Laura Dolan. Thanks for joining us, Laura.

Laura: Thank you for having me.

Robyn: Well, if you’ve ever thought about lending money to your kids to help them buy a property or if they have asked you to go guarantor for a home loan, then today’s discussion is for you. We are going to talk about inter-family loans or what is otherwise being referred to as the ‘Bank of Mum and Dad’. Let’s start with why this is such a hot topic at the moment, and why everyone should understand the risks associated with lending children money to secure property.

Laura: The ‘Bank of Mum and Dad’ is a common term that’s been around for a long time. Historically, many first-home buyers have had some kind of financial assistance from their parents or grandparents to help them enter the property market. Although this isn’t a new concept, we’ve seen significant increase in people relying on their parents for financial assistance. With mum and dad now sitting on more equity in their homes than ever due to the increase in property values, first-home buyers are leveraging off this more than ever before to combat the rising property prices and interest rate hikes. But it can be a double-edged sword, and there’s some stark warnings for parents and grandparents who are considering providing financial assistance to their children or grandchildren by way of an inter-family loan.

Robyn: So, should parents or grandparents be getting advice before lending children money?

Laura: We know that it can seem clinical or unnecessary to put formal documentation in place when you want to help a child or grandchild out financially. Everyone is excited about the prospect of securing their first property, and parents have had the best of intentions wanting to support their children and help them achieve their goals. But no one has a crystal ball as to what the future holds, and when it comes to money, it’s never as clean-cut as people hope. Getting the right advice and documenting an agreement doesn’t have to be complex or an overwhelming task. It is simply just ensuring that you are capturing the discussions being held at the time in regards to the money being loaned. There needs to be a clear understanding as to what everyone is agreeing to.

So, documenting the agreement early can save you and potentially other family members a lot of stress and legal costs if for some reason something changes and the original agreement is not honoured.

Robyn: So, what type of financial assistance are we referring to when parents lend money to children?

Laura: It can be a number of things. So, it can be agreeing to be a guarantor on a loan, allowing children to live rent-free until they’ve saved enough money for a deposit to purchase their first property, gifting a child a lump sum of money to go towards the deposit of a new home with the intention that that money is to be repaid, or even purchasing a home for their children with an agreement in place that may see the children rent-to-buy and paying rent, which ultimately ensures they end up owning the home once it’s paid off.

All of these scenarios carry risk, and it’s important for parents or grandparents to understand that despite their hearts being in the right place, there still are things to consider.

Robyn: And how common is it for first-home buyers to tap into the bank of mum and dad?

Laura: The bank of mum and dad has become so large as the home loan lender that it is estimated to sit somewhere between the 5th and 9th biggest mortgage lenders in Australia.

Robyn: Wow.

Laura: So that’s a lot of people relying on their mum and dad to financially support their property investment goals. The Productivity Commission has estimated that the number of children receiving the home loan assistance from their parents has doubled in the last 20 years.

The most common way support is being given is when people are getting their parents to go guarantor on a home loan, or by accepting a cash gift to go towards the deposit. In some cases, parents set an expectation that this cash gift needs to be repaid, but they do not put any formal agreement in place because, after all, families shouldn’t have to argue over money, and it will all work out in the end, right? But when a parent uses that equity in their home as security for their child to purchase a property, they are ultimately taking the responsibility on for that home loan as well.

Robyn: And what are some of the issues that can arise when parents or grandparents choose to loan children or grandchildren money to purchase a property?

Laura: One of the biggest issues is that often these arrangements are being made informally, and there’s no documentation put in place that sets out the party’s expectations and obligations. For example, there may be an agreement that a lump sum amount lent to an adult child is being repaid over a period of time. It’s also very common for the child receiving the loan to be in a relationship, and ultimately taking on the responsibility as a couple to repay that loan. Although parents or grandparents may be open and honest about their intentions and expectations when giving money to a child and their spouse, disputes often arise over the terms of the loan if that child’s relationship comes to an end.

Robyn: Yeah, it’s all good until it’s not. What happens if someone has lent money to their child and their spouse, and they get divorced before the money is repaid?

Laura: This scenario is more common than people think, and something we’re seeing more and more of. So, parents decide to loan their child money to go towards their new property. That child is in a very serious relationship and will be purchasing the property with their partner. There is usually a general discussion as to how that money will be repaid over a certain period of time. A year passes after the couple purchases the property, and then they broke up.

Usually, the ex-partner is not prepared to concede that the money loaned was a loan, and what they often claim it was a gift. This is a common scenario, and we just see it play out all too often.

What can happen when parents get involved in their child’s property settlement matter before the family court? The parents or grandparents then rack up the legal costs in obtaining legal representation to argue that the money loaned to the couple was indeed a loan, and that they must try to secure an order for the loan to be repaid.

Robyn: And what happens if the court determines that the loan was intended as a gift because there is no formal documentation in place to prove otherwise?

Laura: Then, the loaned money, which in many cases is the equity in a property owned by the parents, will form part of the asset pool in a property settlement to be divided between the child and their former partner. This generally means that the parents will not be repaid and, in essence, lose their money. There are so many cases we could reference where this issue has unfolded in the legal arena. One particular example is the case of Carpenter and Carpenter, where a father loaned $200,000 to his son and his wife so that they could buy a land in which they intended to build their first family home. No formal agreement documented. And when the time came, the husband and wife separated. The husband attested to the fact that the money was a loan and needed to be paid back. The wife, however, asserted that the money was a gift.

On the basis that the father understood how his son and then wife intended to use the funds he provided, the court determined that the father had gifted the money to financially assist his son and wife. This meant the money did not need to be repaid, and the value of this gift remained in the asset pool for the benefit of the wife.

Robyn: So Laura, how can families avoid this situation if they want to help their children out and loan the money like so many families want to do?

Laura: It’s imperative that any inter-family loans are properly documented by utilising a loan agreement. It is a simple step to take, however, a valuable one as a loan agreement can ensure parents get complete security of the repayment of the loan.

And if for any reason the breakdown of a relationship comes into play, the parents would have a strong case against any argument raised that the money intended was a gift.

Robyn: Yeah, that’s a great tip for any parents lending money to a child and their child’s spouse. Besides these issues, are there any other considerations parents should be aware of when lending money to children?

Laura: There are issues around estate planning when you’re lending money to one child. Something that needs to be considered is what happens if the parent dies, and the loan is still outstanding? What impacts might this have on any other children or loved ones that the parents may have wanted to provide for in their will? So, disputes often arise after parents have passed away when one child has received a significant amount of money, whether it was intended to be paid back or not, and other siblings argue the amount should be paid back to the estate before it’s distributed.

Obviously, this isn’t a nice thing to have to think about, but it is an important factor as the lending large amounts of money can make a significant impact when planning for the future. And determining how your estate will be divided is something unexpected happens to you. It is important that any loans are not only documented in a loan agreement between the parties involved, but the parents also document the loan in their will to ensure their wishes are clear and in respect to any loans made to the children if they need to be repaid. In some cases, parents may want to include in their will that the loan will be forgiven and does not need to be repaid in the event of their death.

There can also be issues around capacity and if the child who is receiving the loan is also the person appointed as their parent’s enduring power of attorney. So, if there’s any capacity issues in relation to the parents, there could be a conflict interest where a child who is the power of attorney accepts money or equity from the parents they are supposed to be advocating and caring for. So, in addition to the estate planning factors I’ve just mentioned, there are also financial considerations people should understand before loaning money to family. There may be tax or settlement issues, but there are also financial considerations people should understand before loaning money to a family.

These are just some of the reasons why it is wise to not only obtain legal advice in these types of scenarios, but to obtain taxation and financial planning advice if you intend to loan money to a family member.

Robyn: Yeah, what sounds like a simple idea can be really complex as you’ve just explained today. And there’s no secret that money disagreements can destroy families. And you’ve certainly provided some great takeaways for people to consider if they are intending to help their children or grandchildren out financially. Thanks for joining us today, Laura.

Laura: Thank you so much for having me.

Robyn: You’ve been listening to Law Talks here on 4CRB, which you can hear every Friday morning from 9 o’clock. And this interview is also available on our website, 4CRB.com.