The Bank of Mum and Dad:  Tips for Parents Loaning Money to Children

With many prospective homebuyers eagerly awaiting the RBA’s first interest rate cut, we’ll likely see more young Australians turning to the ‘Bank of Mum and Dad’ for financial support

While helping your children enter the property market is a generous and rewarding gesture, it can also lead to legal disputes, financial strain, or unintended family tensions if not carefully planned.

How Big Is the Bank of Mum and Dad?

Parents collectively lend around $35 billion to assist their children with homeownership. However, as outlined above these informal arrangements can lead to significant financial and legal complications, particularly if relationships break down, a child declares bankruptcy, or a parent suffers loss of capacity or passes away.

Before lending money, it’s important to clarify these key points:

• Will there be repayment terms, security, or interest?
• How will the loan be treated in a divorce settlement?
• Will the loan be legally documented for protection?

Here are six key considerations before lending or gifting money to your children.

1. Define the Arrangement Clearly

• Gift or Loan? Decide whether the financial support is a gift, a loan, or a combination of both. If the goal is to help your child avoid Lenders Mortgage Insurance (LMI), a gift may be more beneficial. However, if you expect repayment, formalising the loan with legal documentation is essential for protecting everyone involved.”
• Put It in Writing: Draft a formal and legal written agreement outlining outline the terms of any loan, including repayment schedules, interest, and security. This can prevent misunderstandings and reduce the likelihood of disputes.

2. Secure the Funds

• Legal Protection: If you’re lending a significant sum, consider securing the loan with a mortgage or caveat on the property. This provides legal backing and reduces risks.
• Avoid Informal Agreements: Verbal agreements or “handshake deals” can lead to disputes and are often unenforceable. Proper documentation ensures peace of mind for all parties.
• Insurance: Encourage your children to have appropriate personal insurance (e.g., Life, Total & Permanent Disability, Trauma, and Income Protection). These policies can provide financial security in case of illness or injury, reducing the likelihood that they’ll need further financial assistance from you.

3. Be Mindful of Family Law Implications

In Australia, the median marriage age is 29.5 for men and 27.3 for women, while the median divorce age is 45.9 for men and 43 for women. Given that many parental loans span decades, ensuring legal protection is crucial to prevent financial losses in the event of a relationship breakdown

• Protect Against Separation or Divorce: If your child separates from their partner, financial support or contributions may be treated as a shared asset.
• Binding Financial Agreements: If your child is in a relationship, encourage them to consider a financial agreement that specifies how parental financial contributions will be treated in the event of a separation. This can help prevent legal disputes and financial loss

4. Consider the Impact on Your Own Finances

• Don’t Overextend: Ensure your assistance won’t compromise your retirement savings, lifestyle goals, or financial stability.
• Consider Inflation: Positive inflation means that over time, the amount your dollar buys decreases. Assuming 3% inflation, an interest free loan will lose 26% of its purchasing power over 10 years and 46% over 20 years. Should you be charging interest?
• Consider the Opportunity Cost: Gifting or lending money means those funds are no longer available for investment, which could impact your long-term financial goals. The annual return for the Growth Composite Index is approx. 8% pa over the last 10 years, can you afford to give this up?
• Services Australia (Centrelink/DVA) Implications: Be aware that gifting large amounts could affect your eligibility for a means-tested pension or Centrelink benefits. Centrelink will presume the money provided to a child from a parent was a gift unless the parent can prove there is a genuine loan (i.e. a documented loan). How the loan and/or gift affects any income or assets tests for Centrelink/DVA benefits should be carefully considered.

5. Discuss Mortgage Repayments and Budgeting

• Start the Conversation About Finances: Speak to your children about how they plan to manage the ongoing costs of homeownership. Will they live in the property or rent it out to generate income?
• Budgeting for Success: Help your children create a budget that accounts for mortgage repayments, property maintenance, and other household expenses. This ensures they’re financially prepared for the responsibilities of homeownership.
• Explore Repayment Strategies: Consider options like making extra repayments to reduce the loan term or using offset accounts to minimise interest. These strategies can help them pay off the loan faster.
• Emergency Fund Planning: Unexpected costs such as home repairs, rising interest rates, or job loss can strain finances. An emergency fund can provide a safety net, reducing the risk of financial stress

6. Review Estate Planning and Family Fairness

• Update Your Will: If you’ve provided one child with financial help, ensure your estate plans account for this to maintain fairness among siblings.
• Have Open Conversations: Clear communication with all family members can help prevent disputes or misunderstandings about your intentions.

How Can Morrows Help?

At Morrows, we understand that whilst supporting your family is important, thinking about the financial and legal implications are just as crucial. Our Morrows team of legal, financial, insurance, and estate planning advisors can assist you in:

• Drafting legally sound loan agreements to protect your contributions.
• Reviewing your estate plan to ensure family fairness and prevent disputes.
• Assessing the impact on your financial goals, retirement savings, and pension eligibility.
• Facilitating family discussions to align expectations and minimise risks.
• Offering budgeting advice and strategies to help your children manage mortgage repayments effectively.
• Review insurance needs and put in place a tailored insurance plan that balances cover objectives with affordability.

Contact your Morrow advisor today to ensure your financial support benefits your children while safeguarding your own financial future.