Parents are increasingly digging deep to get their children and grandchildren into the property market. So, it’s imperative that any financial support is documented, and all parties fully understand what’s involved.
Retirees considering financially assisting their children or grandchildren to enter the property market need to think long and hard about a decision that can cause family breakdowns and further embitter divorce proceedings. Even in close-knit families, any financial transaction should be legally documented – particularly whether it’s a gift or a loan.
That more inter-generational loans or gifts – colloquially known as the bank of mum and dad (BOMAD) – are increasingly turning sour is hardly surprising given their growing role in the $10.7 trillion residential property market, with the Productivity Commission estimating BOMAD is between the fifth and ninth biggest mortgage lender and 60 per cent of first home buyers get some form of parental assistance.
In most instances, recipients welcome and appreciate these loans or gifts, and parents are pleased to assist in getting their offspring into an expensive market – a powerful legacy. Moreover, while the BOMAD loans may have become ubiquitous, many offspring still eschew tapping the wallets of their parents or grandparents as the latest AMP research illustrated.
But when BOMAD loans or gifts implode, family relationships rarely survive the fallout. Melbourne-based Hicks Oakley Chessell Williams senior associate Andrew O’Sullivan-Newbold cites three factors why the BOMAD financial dealings fail.
“The biggest reason is that the law presumes that when money is transferred from parents to their child, it’s a gift, and not a loan – the presumption of advancement – unless there is documentation stating otherwise.
“Second, all parties had no idea about the presumption of advancement, so they erroneously assume that everything will be okay and that there is no right of recovery that a creditor would normally have under a loan agreement.”
He added that the third biggest reason was that the BOMAD and the child entered into a loan agreement, then forget about it and, when challenged in court, was found not to be on commercial terms and that the money was a gift. Reasons for that court finding could be the failure to register the mortgage or caveat on the title, no security for the loan or no interest charged.
Tweed Heads-based Stacks solicitor David Crossan sees the failure of the BOMAD loans and gifts through a different prism. “A breakdown in a relationship with the child or the child’s spouse or defacto is one reason these financial arrangements fail. Another is a change in the parents’ circumstances where they require funds urgently. Alternatively, a child either can’t or refuses to refinance a loan to release the parent’s property from a mortgage that secures the guarantee for the loan.”
He added that it was uncommon for parents to over-extend themselves. But when it happened the results were catastrophic.
“This is particularly the case for those parents that have provided guarantees for a child’s loan and the child has gone bankrupt, or the parent requires the mortgage over their property to be released.”
From his experience, O’Sullivan-Newbold said the best options for the BOMAD to advance money to their children in the context of a family law dispute were:
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A binding financial agreement – contracts between parties about how assets will be divided if they separate – providing for the spouse whose parents provide the loan to retain the money or equity in the property that the loan is applied to and the liability to repay their parents, indemnifying the other spouse against the debt to their parents.
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Loan secured by mortgage.
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Loan secured by caveat.
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Unsecured loan.
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Gift.
He added that loans were better if the parents had associated entities, such as a family trust, instead of the parents individually. Obviously, many people do not have such associated entities, and, for most, it was not worth the effort.
“Remember, too, loans should not be on a handshake. It’s imperative the parties have a written loan agreement legally drafted,” he said.
Guarantees are different. Parents can guarantee an adult child’s mortgage without having ever had to advance any money – provided their child keeps up the repayments.
O’Sullivan-Newbold said: “If the BOMAD would like any money paid to the bank under a guarantee repaid to them, they could have a collateral loan agreement under which the adult child repays the BOMAD – but check that this does not contradict any representations to the (retail) bank about that loan is being made or to Centrelink.”
David Crossan stressed that retirees getting a means-tested pension should not gift their offspring money as it could affect their pension – and the potential issues do not end there.
“Gifting an asset gives away a financial resource that can’t be recovered. In addition, it means the subject matter of the gift is available if the child is sued, becomes bankrupt or is involved in a divorce or separation. It may also require a will to be amended to ensure fairness in an estate plan.”
He added that guarantees should be avoided as they last until the debt it secured was fully paid. Consequently, a guarantee may exist for the life of the loan and affect your estate – sometimes as long as 30 years depending on the terms of the loan.
Remember, too, that secured debts are always easier to recover than unsecured debts. In a family law context, it gives the appearance that the money was advanced on commercial terms and therefore more likely to appear to be a loan and not a gift.
Crossan strongly recommended that any loan was secured by a mortgage. He said: “If the loan is not secured by a mortgage and the child goes bankrupt, then the monies loaned cannot be recovered. And a properly documented loan to a child will assist if the child divorces or separates from a spouse or de facto.”
In an Australia of booming housing prices, author Jake Slope’s truism, parenting is a life-time job that does not stop when a child grows up, never seemed more valid. So, many retired parents who can afford it – and even some who can’t – will dig deep to help their offspring. Just make sure the legal bases are covered.
Should you be considering assisting family, we cannot stress enough to ensure you have the correct agreements in place.
Reach out to Pinnacle if you need further assistance in this area.
