What parent doesn’t want to help their children make a success of their lives?
That’s no doubt why we hear so much about the ‘Bank of Mum and Dad’, the jokey-but-accurate name for the increasingly common phenomena of asset- and, for the particularly fortunate, cash-rich Baby Boomers who help their adult kids on to the property ladder with a deposit for a property purchase or even a property itself.
Don’t believe the hype? As early as 2016, St.George Bank flagged that an increasing number of parents were using a mortgage guarantor product to help their children buy a home. Use of the Family Pledge product, which allows homeowners to use equity in their property to guarantee a family member’s mortgage, increased 9 percent in just the previous 12 months.
That was backed up by an oft-cited survey by Mozo.com in September 2017, that found the Bank of Mum and Dad was the country’s fifth-largest lender, having forked out $65.3 billion in loans and gifts. And just three months later, almost 80 per cent of parents told St. George that they were willing to make a sacrifice or compromise to assist their children on to the property ladder, including giving up luxuries or holidays or living a less comfortable life to provide financial assistance.
The desire to lend a hand across generations is admirable, especially when considering few Baby Boomers received financial assistance from family for their own first home purchase.
But Diana Saad, a senior financial adviser at BT Financial Group (BTFG), cautions that if you’re considering doing the same, it’s vital to assess how it’ll impact your own financial future, and to examine your own reasons for helping, to ensure it’s the right decision for you and your family.
To do so, she suggests asking yourself these questions.
“A lot of parents get huge emotional satisfaction and peace of mind in knowing that their children are financially taken care of and knowing that they have been able to help out their children during their lifetime,” Saad says, adding that providing financial assistance during life can be particularly helpful for people with blended families, because it allows them to better control how funds are distributed and used.
“You might have a complex family dynamic where leaving an inheritance can be tricky and estates can be challenged,” she explains. “That’s when clients can be a bit more inclined to help the kids out financially in their lifetime, because then they know for sure that if they were planning on bequeathing a certain asset or a certain amount of cash, that particular child or intended beneficiary’s going to get it.”
If you have more than one child, Saad says considering whether you’ll be able to offer them all equal assistance during your lifetime is also key.
“If you help one child and then it comes time to help the second or the third child and you don’t have the financial resources to do so, be mindful that it can potentially create friction in the family,” she says.
Unspoken expectations, emotional or otherwise, that the financial recipient will respond in a certain way can cause conflict down the track, Saad notes, so it’s best to address these issues before any money changes hands.
“It’s really important to have open and honest conversations around expectations of commitments around that financial help,” she says.
These commitments could range from expecting an adult child to care for you in later life should the need arise, to expecting that the funds and any growth they return will remain in the family’s asset pool.
“Think about what would happen if you help your child out financially and you disagree with their financial decisions, how will that effect you? What’s the relationship going to look like if that was to happen?” Saad advises.
“Or if they were to go through a marriage or de facto relationship breakdown? Suddenly that money or asset that you’ve contributed to your child becomes part of the joint assets pool that’s subject to family court decision as to how those monies and assets should be split and you could potentially lose control over that money.”
The situations above, and many others, can be dealt with by setting out the nature of your ‘deal’ with your kids in writing, with or without the help of a solicitor – but that requires a conversation with your children about your desire for a formal contract with them.
While such a conversation may be uncomfortable, Saad recommends it to her clients on every such occasion, followed by a detailed, written record of your agreement, ideally drafted with professional advice.
“It may be that there’s an opportunity to draft a legal document so all parties are aware of what they are entering into and limit some of your risks,” she says. “The legal limitations will vary on a case-by-case basis, and there will be different circumstances for lending and gifting money, so it’s always prudent to seek advice,” she adds.
A written agreement should include details of any repayment plan, including any interest rate you intend to charge and the timeframe for repayment, what would occur if your child defaults on their loan either to you or to the mortgagor and any restrictions you wish to place on the funds, such as how they would be treated in the event of a relationship change or if there’s a capital gain made on the funds.
If you’re using your home equity to guarantor your child’s mortgage, the agreement should also set out the value of both homes at the time of the agreement, the timeframe in which you wish to withdraw your guarantee and what would happen in that event.
Unless you have unlimited assets, assisting your children financially, whether it’s through a cash gift or loan or by using your home equity to guarantee their mortgage, could impact your own freedom to, say, have the sea-change you’ve always dreamt of.
“It’s not unusual for older clients to be up the coast one day, and they might have absolutely no plan to buy anything, but they see a cute little cottage on the beach and say, ‘Yep, we’ve decided to downsize, so we want to sell our house and buy this one’,” Saad explains. “It’s important to think about whether you’re the type of person who may potentially want to do that, and whether you’re willing to forfeit that flexibility to help your kids out.
“What’s of greater value to you – the emotional satisfaction of helping your children versus the flexibility to do more financially yourself – is a very personal question that only you can answer.”
This, of course, is the killer question, that requires looking not just at your current financial situation but how you intend to fund your retirement for what may be decades in the future.
“If people don’t plan carefully before giving money to their children, they might end up being short on funds themselves to meet their financial goals,” Saad warns. “For example, they might not have enough of an asset base to meet their retirement income expenses, or if they were planning to buy another asset, they might have limited some of their own borrowing capacity.”
She says the latter consideration is particularly pertinent at present because banks are tightening their lending criteria, so having a over your home equity or having a reduced cash buffer could see your own borrowing costs go up or even prevent you from borrowing.
Another issue that sometimes gets missed by the Bank of Mum and Dad is the cost of freeing up funds to lend. For example, selling stocks outside superannuation comes with an upfront transaction charge, as well as the less-easily-measured cost of the future returns you may be forgoing on those stocks – all of which should be considered when calculating your personal cost of lending or gifting.
Your planning should also include a ‘worst case scenario’ contingency plan. Put simply, if you can’t afford to possibly lose the money you lend, you should perhaps consider if becoming the Bank of Mum and Dad is right for you at this point.
Saad says when thinking about this aspect of being the family banker you need to acknowledge that changes in life circumstances can inadvertently impact best-laid plans.
“Your child could become ill or injured and despite their best intentions, not be able to work, or fall pregnant unexpectedly and have to take time off work, which also means less income coming in,” she explains. “it’s really important to allow for the fact that these sometimes unexpected events can take place.”
Things you should know: Information current as at 30 September 2018. BT Financial Advisers are representatives of Westpac. BT Financial Advice is a division of Westpac. The information in this publication is general information and factual only. It does not constitute any recommendation or financial product advice. The information has been prepared without taking into account your personal objectives, financial situation or needs and so you should consider its appropriateness having regard to these factors before acting on it. This information may contain material provided directly by third parties and has not been independently verified and Westpac Banking Corporation is not in any way responsible for such information. ©Westpac Banking Corporation ABN 33 007 457 141 AFSL and Australian Credit Licence 233714