Opening the Bank of Mum and Dad? Know the risks
As house prices continue to surge, so do the requests for financial support from parents.
Digital Financial Analytics reports about 60 per cent of first home buyers are going to the Bank of Mum and Dad for assistance.
Most commonly, assistance is sought in the form of a house deposit or asking you to go guarantor on their loan.
A low-interest and perceivably low-risk loan that avoids financial institutions is understandably attractive for both parties in these circumstances. As a parent, you want to help your children secure their own homes, but make sure you plan for the risks involved.
The first and most obvious risk for the lender is that the borrower will default on payments.
A traditional mortgage allows a lender to take possession of the property if payments are not made, but private financial arrangements often lack this security. This unwanted outcome can leave parents seriously out of pocket.
Often, the loan may be for co-owned property, where your child is in a de facto relationship or married. In this instance, your child’s spouse or domestic partner should be privy to the formal arrangement, preferably in writing.
The loan agreement can also contain mechanisms to ensure the loaned funds do not get tied up in family law proceedings in the case of separation or divorce.
Other frequently overlooked risks include when your child, who initially borrowed from you independently, goes on to develop a relationship where a partner who may become entitled to any equity in the property if they separate.
Also, it is important to consider what happens if the loan is unpaid when you’ve passed away, and if that loan is factored into your will. If you have a pension, ask how the loan could potentially impact your Centrelink payments.
A crucial precaution is to document all of the details of the financial arrangement, whether it is a loan or a gift. Not only does this ensure the specifics are recorded and remembered over the long lifespan of a loan, it is evidence that can be provided to banks, creditors, lawyers, trustees or Centrelink when needed.
It is also important to secure your loan. As most loans from the Bank of Mum and Dad go towards the purchaser’s equity such as a deposit, the borrower will often enter into a mortgage with a major lending institution.
While major lending institutions are likely to have a first-ranking mortgage (first rights to a forced sale in the event of loan default), parent lenders can still seek security for the loan in many different forms such as a second-ranking mortgage, a caveat, an unregistered mortgage or even security of personal property and assets.
Remember, if you are opening the Bank of Mum and Dad, make sure you seek the appropriate financial and legal assistance. These contracts and agreements can be complex and are best executed by professionals. This will give you peace of mind that your agreement is well-documented and that your loan is secure.
Head to coulterroache.com.au for more information.