Topic 6: Three big questions to answer before opening the Bank of Mum and Dad
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Aussies largely agree on one thing: it’s tough to buy a home on one income these days.*
That’s no doubt why three-quarters of parents say being able to help their offspring buy a home is important to them.**
And for two-thirds of the generous parents who stump up help in the form of cash, repayment isn’t a concern.***
But what of the parents who want, or need, their loan repaid?
In those circumstances, acting as the Bank of Mum and Dad comes with a few risks worth serious forethought before any cheque is signed.
Answering these three big questions, and deciding on a course of action, will provide you with some peace of mind.
Do you plan to document the loan?
If you decide to lend a sum of money directly rather than via a joint borrowing or guarantor product, it’s vital to carefully document your agreement.
It’s best to have the written loan agreement acknowledged by you, your adult child, and if appropriate, their spouse or partner. That’s because although a verbal contract is legally binding, without written evidence it may be difficult to later prove the terms of the agreement.
Likewise, writing an I.O.U. note but failing to have it signed won’t be as helpful as a signed document should the worst happen.
When creating the document, make sure you clearly define the exchange of money as a loan, and set out details such as repayment terms, any interest payable, and the actions that’ll be taken in the event of a default.
Making clear the transaction’s a loan, not a gift, is important because a gift could become part of your child’s joint assets if they’re married or in a partnership. Should their relationship break down while the loan’s outstanding, the money you ‘lent’ would likely be divided between the couple as an asset, likely dashing your chances of a full repayment.
When setting the terms of the loan, make sure you obtain security over some or all your child’s assets. Without this, you may rank behind other creditors in the repayment queue if your child declares bankruptcy while the loan’s outstanding.
If you’re reluctant to seek legal advice to create a loan agreement, an Australian site called Credi allows you to make and manage personalised loan documents online at little cost.
Do you plan to discuss the issue with the family?
Who you disclose the loan to – now and in the future – can help head off family disputes down the track.
If you have more than one grown-up child, it’s worth considering whether to discuss the loan with them before completing the transaction –they may have thoughts on the issue that you were unaware of or hadn’t already considered.
Such a chat could help minimise any ill-feeling in the event of a default.
It’s also key to consider the loan in the context of your broader estate planning.
Your will and other estate planning documents should be updated to show the existence of the loan, and clearly note whether you plan to forgive the debt in the event of your passing.
If you do decide to forgive the debt, think about whether you’ll also ‘compensate’ other loved ones to the value of the loan by bequeathing them additional assets.
Again, setting out your intentions in no uncertain terms, and ensuring that any legal and financial advisers understand them, will likely help prevent disagreements after you’re gone.
Do you have the means to cover the loan yourself?
If you buy a property with a loved one via a joint mortgage, it’s important to be aware that you’ll be held responsible by the lender for repayment, regardless of any private arrangement you may have made with your child.
That means that if your son or daughter is unable to make their loan repayments, you’ll be on the hook for the full amount.
if you’re also unable to meet the repayments, it’ll almost certainly affect your credit rating, making it difficult to borrow money for years in the future.
Lenders are usually open to loan renegotiations that make it possible for you to repay a debt, but worst case scenario, you could be forced to sell your own home to repay the debt, or even declare bankruptcy yourself, if you’re unable to meet the repayments.
Being the guarantor on your adult child’s loan by using your own home equity cuts some of these risk, because it allows you to cap your exposure to the loan.
If your child defaults on a guarantor loan, you’re responsible for the portion of the loan you offered you own home as security against. However, in a worst-case scenario, this could mean selling our own home to cover your portion of the debt.
St. George, for example, requires all customers using its home loan guarantor product take independent legal advice before putting equity in their home up as security on a loan.
Meanwhile, if you’re reliant on loan repayments from your child as form of income, it’s smart to ensure that you have an ‘emergency plan’ for how you could do without the money coming in.
One possible solution for these risks is to ask your child to take out income protection insurance, so repayments to the bank, or you, are covered if they lose their job or are unable to work.
“If the loan repayments are reliant on their income, it’s important to think about how they might manage to continue repaying the loan if they were unable to work, for example due to an illness or injury,” Ross Miller, General Manager of St.George Retail Bank, advises.
Are you happy to lend money, or take loans, from family members? Or do you worry that it’s a recipe for argument?
*82 per cent of Australians surveyed by St. George Bank agreed that ‘few can afford a home on only one income these days’.
**74 per cent of Australian parents agreed that ‘being able to help their children on their home ownership journey is important to them’