The Bank of Mum and Dad: what do families and their advisers need to consider?

However parents choose to assist their children into the property market, the arrangement should be legally documented

Many parents who were looking forward to a debt-free retirement are helping adult children enter the property market – and the Australian Treasury is worried.

Parents’ role in financing their homebuyer children has become an economic and political issue, with implications for financial advisers, lawyers and regulators concerned about older Australians’ financial security.

Not only are adult children taking longer to leave the family home, thousands are turning to their parents for loans, gifts and guarantees to help them buy their first property.

Treasury secretary John Fraser says it is a worrying development.

“The bank of mum and dad … is becoming more and more prevalent,” Fraser told a Senate Estimates hearing in October.

“It has impacts on superannuation – where superannuation is going to. It has impacts on why people are saving in their older years, to fund their children's housing needs, and not just purchases, but often rents. And it is a concern. [This] is an issue that is prevalent around the world.”

Economist Martin North, principal of Digital Finance Analytics, has been closely documenting the trend. He reckons 52 per cent of first home buyers are now tapping their parents for funds – up from just 3 per cent six years ago.

His research shows the amounts children are asking for have risen in virtual lockstep with spiralling house prices, from an average request for A$23,173 in 2010 to A$83,397 in 2016.

It is not hard to see why younger people entering the property market need help.

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Australian house prices have soared 73 per cent in the last 10 years. Over the same period, wages have grown by 37.5 per cent, and banks have tightened their lending standards. An international survey has rated two-thirds of Australia’s property market as “severely unaffordable”.

Little wonder that first home buyers, who accounted for around a third of all property transactions eight years ago, now only make up 13 per cent of the market.

The increased cost of housing is also affecting the kind of help parents can provide.

Five years ago, the most common form of support was for parents to go guarantor on the loan. But North says rising prices have pushed deposits beyond the reach of many, rendering any guarantee moot. Instead, his household surveys have found that of all homebuyers seeking parental assistance, 40 per cent are asking for help to put together a deposit. In almost 25 per cent of transactions, parents are subsidising ongoing mortgage repayments.

Fewer than one in five loans to first home buyers are now guaranteed by a parent.

Is a parental loan a help out or handout?

While the desire of parents to help out children is understandable, particularly if they have benefited from the surge in house prices, financial planners urge caution.

Steve Greatrex, of Wealth on Track, warns of the danger that, in dipping into their savings or superannuation to aid their kids, parents leave themselves short.

“People can leave themselves badly exposed if they underestimate how long they will live for or what their costs will be.”

If parents are intent on helping out, Greatrex says the preferable approach is to act as a guarantor, so that their children can get a loan. But parents need to understand that this is not risk-free: if their child cannot make their repayments they will be hit financially.

For this reason Natalie Copeland, of StrategyOne Advice Network, advises her clients to look for family pledge loans that set a limit on the size of the guarantee.

Both Copeland and Greatrex advise that parents who go guarantor should look to exit the arrangement as early as possible.

“Parents have to be very cognisant of the risks and need to have a very clear plan about when to get rid of the thing,” Greatrex says. Copeland recommends that the terms of the guarantee be regularly reviewed.

Particularly in a market where property prices are rising, she urges that the property be regularly re-valued to check if and when it reaches the point at which the lender is comfortable about releasing the guarantee. She warns that banks will rarely do this of their own volition – it is something that guarantors will have to initiate. Furthermore, parents going guarantor should be aware that this will only work in a rising market – something that cannot be relied upon.

The gift of giving from parent to child

More direct forms of financial assistance, such as gifts or loans, come with their own complications and risks. Copeland says changes in a child’s circumstances, like getting married or divorced, can cause parents to rethink their assistance.

Even though providing a loan might seem a sensible option, Greatrex is wary.

“Parents need to ask themselves: if the bank is not prepared to lend them money, should I be lending them money?” he says. “If you are going to loan the money, you have to be prepared to lose it.”

Banks will not accept a loan as a contribution toward a deposit. Instead, Copeland advises, parents can provide funds as a gift, but cover themselves by setting out the terms of the gift in an asset protection contract. Such a contract can specify how any assets might be treated in the event of a change of circumstance, such as a relationship breakdown.

Copeland says parents or their financial advisers need to inform the lender of such an arrangement, and are usually required to make a statutory declaration.

An alternative arrangement that she says is becoming more common is for parents to use a term deposit with the lender as a form of security against a loan by their child.

Apart from dipping into their own savings or taking out a second mortgage, parents are sometimes tempted to use part of their superannuation to give their children a leg up in the property market.

Copeland warns that such a move should only be considered as a last resort and “very carefully thought through”.

Apart from the risk that the money will be lost, reducing the parents’ stream of income in retirement, they also need to take into account whether they will be able to channel the money back into their superannuation if and when it is repaid. Will they still satisfy the work test, or meet the non-concessional contribution rules? she asks.

However parents choose to assist their children into the property market, Greatrex and Copeland agree the arrangement should be legally documented, setting out clearly the terms under which assistance is provided.

A loan or a gift?

Can a loan become a gift?

Surprisingly, the law seems to say yes.

Lauren Patford-Smith, a family lawyer with Hutchinson Legal, says that, in the absence of clear laws on the issue, courts are coming to their own conclusions.

In one case in 2011, a father loaned his son A$320,000 to help purchase property. The loan was documented, but no repayment was made or interest paid. When the son subsequently wed, the court ruled the couple was liable for the sum, which was paid out of the matrimonial pool.

In another case, a father gave a couple A$240,000 to help buy land and build a house. The contribution was not formally documented and no demand for repayment was made, until the couple separated. The court judged that the father would never have asked for repayment except for the separation, and ruled that the A$240,000 should be considered a gift, not to be repaid.

Patford-Smith says there is no clear rule regarding what parents who want to give their child a loan should do, but suggests it should be documented in writing, have a set term and include the express intention that the money is to be repaid.

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