The Bank of Mum and Dad: A breakdown of the risks and considerations associated with private lending.

As house prices continue to surge, many first homebuyers are relying on their parents, colloquially termed the ‘Bank of Mum and Dad’, for financial support and assistance to get their foot in the door of the housing market. Reporting from Digital Financial Analytics shows that approximately 60% of first homebuyers rely on the Bank of Mum and Dad for financial assistance with funding their first home.

Whilst loaning money to a member of your family can be perceived as low risk and easier than approaching a major lending institutions, doing so carries risks that are often never contemplated by the lender or the borrower.

What are the risks of private lending?

The greatest risk in any form of lending is the borrower defaulting on its repayments.  Ordinarily, a lending arrangement requires a home loan to be secured by a mortgage, which allows the lender to take possession of the borrower’s home if the borrower is unable to remedy its default.

Loans from the Bank of Mum and Dad are often made with very few formalities so that the first home buyer’s equity is boosted.  This means that they are often unsecured.

In addition to the risks of engaging in unsecured lending, loaning money to a child (or any family member) carries risks which can often be overlooked.  Any private lending agreement should consider contingencies to reduce risk.  Some contingencies that should be considered are:

1. The borrower may one day enter into marriage or a defacto relationship.  The borrower’s spouse may therefore be entitled to some of the equity (ie the loan from the Bank of Mum and Dad) in the property if they separate down the track.
2. What happens if you die before your child has paid the loan back to you?
3. What happens if your child’s property is sold in order to repay other debts which are secured by virtue of the property?
4.  What happens if your child co-owns the property with their domestic partner or spouse?
5. Is the loan made to your children documented in your will?
6. Does the loan impact on your pension or Centrelink entitlements.  It is important that appropriate enquires are made in this regard before loaning any funds to your child.

Why enter into private lending?

Assistance from the Bank of Mum and Dad is usually provided so that a first homebuyer is precluded from the requirement for lenders mortgage insurance or a loan guarantor. In most cases, contributions from the Bank of Mum and Dad consist of nominal sums aimed at ‘boosting’ the first homebuyers deposit amount.

Importance of documenting the agreement

Regardless of whether the lending constitutes a gift of ‘love and affection’ or a loan which must be repaid at a later date, it is important to document the agreement reached between the lender and the borrower.

Funds for the purchase of a house are often borrowed for a significant term and may not be repaid for some time.  It is therefore common for people’s memories to fade over time and often, the finer details of the agreement can be forgotten, misconceived or interpreted differently by each party.

What if the funds are a gift?

Further to the above, if the funds constitute a mere ‘gift’ towards the equity of the house, such equity may become tied up at a later date in family law proceedings if your child separates from its domestic partner or spouse.  In addition to this, there is a risk that the equity may become tied up in a deceased estate if you or your child pass away.

Whilst documenting the agreement is crucial to ensure transparency between the lender(s) and the borrower(s), it is also very important that the agreement is documented so that evidence can be provided to banks, creditors, trustees in bankruptcy, Centrelink, executors of your estate or even your child’s spouse/domestic partner to show precisely what the agreement was between you and your child.

Why is it important to secure your loan?

Given that most loans from the Bank of Mum and Dad go towards the purchaser’s equity, the borrower will often enter into another loan with a major lending institution which will ultimately result in that lending institution taking a mortgage over the property that the borrower ultimately purchases.

Although the major lending institution is likely to have a first ranking mortgage, this does not mean that mum and dad lenders are excluded an opportunity to also secure their loan.  Security for a loan can be taken in a number of different forms such as a second ranking mortgage, a caveat, an unregistered mortgage or even security of personal property and assets.

It is important to note that:-

1. any agreement entered into by a lending institution is not considered as a breach by encumbering the title;
2. the loan is secured so that the Bank of Mum and Dad funds are protected, should the borrower (child) default on its loan, or the property become subject to bankruptcy, family law proceedings or otherwise sold at the mercy of the borrower.

What if my child co-owns the property?

In some instances, mum and dad lenders will loan funds to their child so that they can purchase a property with their spouse or domestic partner.  In this scenario, it is important that the spouse or domestic partner is a party to the loan agreement and privy to the arrangement made between parent(s) and child(s).  The loan agreement can also contain mechanisms to ensure that loaned funds do not become tied up in family law proceedings should the child separate from its spouse or domestic partner at a later date.

Conclusion

If you are considering loaning or gifting funds to your child, it is crucial that appropriate legal advice is sought and that the agreement is sufficiently documented in writing between the parties.