Attwood Marshall Lawyers Family Law & Estate Planning Special Counsel Hayley Condon discusses the risks families should be aware of when parents or grandparents lend money to children to purchase property or other significant investments. Don’t let disagreements about money destroy your family.
“The Bank of Mum and Dad” is not a new concept. However, we have seen a significant increase in people loaning funds from Mum and Dad when buying property as interest rates and property prices skyrocket. With Mum and Dad now sitting on more equity in their homes resulting from increased property values, first-home buyers are leveraging this more than ever.
Indeed, family members poured over $2.7 billion into the property market in the past year as first-time buyers sought support in the way of cash loans, gifts or having a guarantor, according to investment bank Jarden.
Digital Finance Analytics estimated that 60 per cent of first-home buyers received some form of financial assistance from their families in 2021. The researchers dubbed the “Bank of Mum and Dad” Australia’s ninth biggest mortgage lender.
There are some stark warnings for parents or grandparents who are considering providing financial assistance to their children or grandchildren through an inter-family loan.
Many expect their children or grandchildren to repay the cash advance, even though no formal written agreement exists. This is where the well-intentioned arrangement can unravel, especially if the parties’ financial circumstances change, whether due to cost-of-living pressures, the breakdown of a relationship, or other unforeseen events.
The need for legal advice before lending family money
Putting formal documentation in place and obtaining independent legal advice when you want to help a child or grandchild financially can seem unnecessary. Everyone is excited at the prospect of their child or grandchild securing their first property, and parents or grandparents have the best intentions to help their loved ones achieve their homeownership goals.
Parents can offer this support in several ways, such as providing a lump sum payment for the property or acting as guarantors for a home loan. In some cases, parents and children may also agree on a “rent to buy” arrangement where the child ultimately ends up owning the home.
All these scenarios carry risks, and parents and grandparents must understand that despite their hearts being in the right place, there is more to consider before providing financial assistance.
Unfortunately, even with the best intentions, no one has a crystal ball. And when it comes to money, it is never as clear-cut as people hope.
The terms of the arrangement that once seemed apparent can become murky over time and open to interpretation depending on what side of the fence you are sitting on (lender or borrower).
Ensuring all parties understand the terms of a cash advance should be straightforward. It involves documenting discussions and agreements when the money is loaned, with the right advice.
Documenting the agreement early on can save you a lot of stress and legal costs if, for some reason, something changes. It can also aid in avoiding disputes that can destroy family relationships.
Let’s look at the issues that can arise
Financial stress: If parents or grandparents rely on loan repayments for their own financial support, and the child or grandchild cannot meet their obligations for whatever reason, the parents or grandparents may find themselves under serious financial stress.
Higher interest rates and living expenses may mean that the child or grandchild is focusing more on repaying the bank than repaying their family member.
Or, they may have lost their job, affecting their ability to repay any of their debts. If the loan has not been documented or secured, the parents or grandparents may end up fighting creditors over the property’s equity.
Risk of losing your property: Another important risk to consider is if a parent or grandparent uses the equity in their own home as security for their child or grandchild to purchase a property (for example, acting as guarantor for the home loan). The guarantor ultimately takes on the responsibility for that home loan if their child or grandchild does not repay them.
Suppose there is a default under the loan, and they cannot meet the obligations of the child or grandchild they guaranteed. In that case, they are putting themselves at risk of losing their own property. To understand these risks fully, seeking proper legal advice before signing any mortgage documents is crucial.
What happens in the event of separation?
For loans given to a child or grandchild who has a spouse or partner, it’s crucial to determine who is ultimately responsible for repayment.
Suppose that the relationship breaks down before the loan is repaid. In that case, one party to the loan could declare that it was a gift and that they had no obligation to repay it. This scenario is more common than people may think, and, in many cases, it is the parents or grandparents who end up losing out and having to cut their losses.
This potential issue often only arises when the child or grandchild and their former partner are in the throes of a property settlement, represented by separate lawyers who are debating whether the loan should form part of their asset pool.
The consequence is that the parents or grandparents are dragged into their child or grandchild’s property settlement matter, which may end up before the Federal Circuit and Family Court of Australia.
The parents or grandparents will then incur legal costs to secure a court order, arguing that the money advanced was indeed a loan to be repaid by the child or grandchild and their former partner.
This problem could have been avoided by consulting a solicitor early in the process, who could have adequately documented the loan arrangement when the advance occurred.
What happens if the Federal Circuit and Family Court of Australia determines that the loan was intended as a gift because there is no formal documentation to prove otherwise?
The money advanced (often equity in the property) becomes part of the asset pool that will be divided between the child or grandchild and their former partner as part of their property settlement.
The parents or grandparents will NOT be repaid. In essence, they will lose their money.
This situation unfolded in the case of Carpenter v Carpenter, where a father loaned $200,000 to his son and his son’s wife.
The couple used the money to buy land on which they intended to build their first family home.
The agreement was not formally documented, and, in time, the son and his wife separated.
After separation, the son asserted that the money was a loan that must be repaid to his father. His wife, however, asserted that the money was a gift.
The court determined that the father had gifted the money to assist his son and his wife financially.
Consequently, the money did not need to be repaid to the father, and the value of this gift remained in the asset pool for the wife’s benefit.
How to avoid these situations
Any inter-family loan must be properly documented by a Loan Agreement.
Depending on the situation, it may also be advisable for the loan to be secured as a mortgage or as a caveat against the title to the property.
These are simple and valuable steps, especially given the real-life cases that play out in court. In the case of Carpenter v Carpenter, if the father documented the advance with a Loan Agreement, he would have had a strong argument against any claim raised by his son’s wife that the advance was a gift and there was no obligation to repay it.
The couple could also consider entering into a binding financial agreement that will set out what will happen and how the loan will be treated in case of a separation. These documents operate like a contract, protecting the assets of each partner and establishing a mutual understanding between the parties.
If the parents or grandparents only want to loan their family member the funds (and not their partner), the couple may also want to look at how the property ownership is registered. Buying property as a “tenant in common” means that the title is held according to each partner’s share or contribution to the purchase price, whereas in a “joint tenancy,” if one owner dies the entire property is passed to the surviving owner.
Document loans in your Will and estate plan
If you are lending money to a child or grandchild, it’s important to consider your estate planning too. Testamentary trusts can be set up to protect your child’s inheritance from future claims by their partner or former partner.
It is also important to understand what impact an unpaid loan might have on any other children or loved ones that the parents or grandparents may have wanted to provide for in their Will.
Disputes often arise after parents or grandparents have passed away when one child or grandchild has received a significant amount of money and their siblings have not received the same financial assistance.
Lending large amounts of money can significantly affect your retirement plans and determine how your estate may be distributed if something unexpected happens.
Inter-family loans should be documented in both a Loan Agreement between the parties involved and in the lender’s Will, ensuring their wishes and intentions are clear.
It can be valuable to outline in your Will what will happen to the loan after death. For example, does it have to be repaid, or will it be forgiven? It would help if you also considered how such loans would be taken into account when dividing the estate among other beneficiaries.
There can also be issues around Enduring Powers of Attorney if the child or grandchild who has received the advance of funds is also an attorney for the parent or grandparent. This can create significant issues later as it could be a conflict of interest.
Taxation and Centrelink issues
There may be other financial considerations that an individual should understand before advancing money to family members. Taxation issues must be considered, especially if a parent or grandparent sells an asset to advance the funds to their child or grandchild.
There may also be Centrelink considerations to be mindful of due to the deeming provisions of loans – this may reduce or cancel your pension payments! This is why it is wise to obtain taxation and financial planning advice if you intend to lend money to a family member.
Attwood Marshall Lawyers – helping families resolve conflict and maintain positive relationships
Money disagreements can destroy families. To avoid disputes arising, get the right advice and documents in place from the start.
At Attwood Marshall Lawyers, we have expert teams that cover both family law, property law, and estate planning. With our lawyers’ experience and skillset, you can have peace of mind in knowing that your inter-family loan is documented properly, and everyone understands their rights and obligations under the agreement.
To discuss our legal services, or if you need estate planning advice, please contact our Department Manager Donna Tolley on direct line 07 5506 8241, email dtolley@attwoodmarshall.com.au or call our 24/7 phone line on 1800 621 071.
You can visit any of our lawyers at our conveniently located offices at Robina Town Centre, Coolangatta, Southport, Kingscliff, Brisbane, Sydney and Melbourne.
