Gift or loan? Navigating the 'Bank of Mum and Dad'

While the ‘bank of mum and dad’ continues to be an appealing source and might seem like a straightforward option, consideration and legal advice on the topics raised in this article is strongly encouraged.

Ultimately it is up to you to determine whether the money you give to your child is to be treated as a gift or loan, but you should be aware of the difference between these two options, and the potential implications.

You may be happy to treat the money you give to your child as a gift, and therefore not repayable, but you need to be aware that there are circumstances where your child may lose that gift.

• Your child’s current (or future) spouse or domestic partner may be entitled to some of the equity in the property, even after their relationship ends.

• If your child becomes bankrupt, the trustee in bankruptcy could be entitled to sell their assets including those your gift helped purchase.

• If your child dies and the property is held as joint tenants with their current (or future) spouse or domestic partner, that person, as the remaining joint tenant, would become the sole owner of the property, even if they contributed little to no financial assistance in comparison to your gift;

• If you die, leaving additional children that are yet to receive a similar gift from you, the gift may result in unintended inequity between the beneficiaries under your will. Your additional children could be entitled to make a claim against your estate for further provision over the child that received the gift.

Any gift given by you may affect your pension entitlements. You should obtain advice from Centrelink about this before making a gift.

If you decide to loan the money to your child, while you may trust them explicitly to repay the loan without the need for a formal loan agreement or mortgage, that may not be enough to protect your funds. The money could still be lost in the same circumstances as listed in the gift section above.

Below are some recommendations and risks to consider.

Hindsight is a powerful thing. While there may be an element of trust between parties at the time arrangements are being made for the transfer of funds, memories will fade and important details and terms can be easily forgotten or misunderstood. Circumstances are also subject to change and even the strongest of familiar relationships can break down.

Having a signed loan agreement in place will help mitigate this. More importantly, at some point in the future, the bank, a trustee in bankruptcy, creditors, Centrelink, your child’s future partner or the Family Court may require proof of what the arrangements were.

• A first mortgage is the best form of security as it means the property cannot be sold without first addressing your interest in the property. Other interests can still be registered against the title, sometimes without your knowledge or consent, but as a general proposition your mortgage will take priority and helps ensure that your loan is repaid first.

• In some instances, your child may already have a first mortgage with a bank, especially if your loan is only a partial solution, in which case a second mortgage will be the next best security. This means that if the property is sold, the first mortgage, including interest and costs, will be paid first. If there is any surplus money left from the sale, your loan will then be repaid.

• It is important to understand how much money is owed under the first mortgage and what ability your child has to increase those borrowings. This will tell you how much equity there will be in the property to pay your loan if the property is sold.

• It is important that all mortgages are registered on the title. If you find yourself in a situation where you have not yet registered your mortgage and are out of time, you should seek legal advice as soon as possible.

Prior to loaning the money, you need to consider what should happen if you die before the loan is repaid. You may decide that the loan will be forgiven in the sense that a deduction is taken from your child’s inheritance or perhaps, the loan needs to be repaid in full on your death, so that the money forms part of your estate. Regardless of which option, careful consideration of how your Will and Estate Planning documents are prepared is critical.

It’s important that the intention and details of the loan agreement are accurately captured, and all parties are in agreeance with the terms of the loan. We therefore recommend completing a loan agreement prior to lending or gifting money. We can however always implement and retrospectively create a loan agreement that is in line with your estate planning.

Transactions of this nature are not something to be entered into lightly, but we understand that where emotions are involved discussions concerning finances can be difficult. Our referral partner network can assist with these difficult conversations and navigate you through the issues and questions that may need to be raised.