More parents are helping their children financially to get ahead. In this article we discuss some of the considerations when gifting or lending money to ensure everyone’s interests are protected.
The ‘Bank of Mum and Dad’ now helps the majority of first home buyers get onto the property ladder. It’s an act of generosity that can come at a price if it’s not done in the right way.
Every parent wants to see their children get ahead. It’s one of the reasons so many parents help their children financially when it comes to buying a home.
More than half (55%) of first home buyers now receive financial assistance from their parents, and where a cash injection is involved the average amount is $89,000. This generosity has made the bank of Mum and Dad the 10th largest lender in Australia, with total loans in excess of $20 billion1.
Support is at hand
Julie Steed, Senior Technical Services Manager2, says some of the recent rule changes around superannuation are a factor in parents being more readily able to support their children financially.
“Over the last few years the Government has tightened up some of the rules around contributing money to super, so people are keeping more of their money invested outside super — where it’s more readily accessible.” Having greater access to cash might be a good thing when it comes to helping out your kids, but it can also have a negative impact on your own retirement savings. “A lot of parents genuinely want to help their children, and it’s great that they’re in a position to do that,” Julie says.
“The downside is that parents might need that money themselves one day — so you need to think about what’s going to happen then.”
A loan or gift?
One of the key things you need to discuss with your children is whether the money is a gift or a loan. Not only can this help your child plan their future, it can have an impact on your Age Pension entitlements — so it’s worth seeking professional advice to avoid any nasty surprises. If the money is a loan, you need to determine what interest (if any) will be payable, and how and when the loan principal will be paid back.
“For example, a parent might waive any repayments for ten years, then ask their children to pay back their loan gradually after that parent is retired,” Julie says. “Or there might be a condition that the loan needs to be repaid in full on divorce to protect the family’s financial interests.”
Another option might be for a parent to act as a guarantor on a child’s loan, using the equity in their home as security for a child’s mortgage. This scenario may help your child secure a loan with a lower deposit than they might otherwise need, but it also means you’re taking on the risk of the debt and the repayments yourself.
“Whatever arrangement you decide on, you should make sure it’s properly documented so there’s no confusion over how it’s going to work,” Julie says. “This can help avoid any misunderstandings or potential disputes later on.”
Keeping it fair
For parents with more than one child, a common objective is achieving a fair outcome for all children. Julie notes this can be particularly difficult when there are siblings from different relationships, or when some siblings need more financial support than others.
“You might have one sibling who is ten years older and was able to get into the property market when affordability wasn’t as much of an issue as it is now, or you may have one sibling who is not as financially responsible and needs a bigger helping hand,” Julie says.
This is where communication is so important — if there’s a reason you’re treating siblings differently, let them know why this is the case and give them an opportunity to share their opinions on the topic.
Protecting your kids (and yourself)
When lending money to your children, there’s always the risk they won’t be able to pay it back when you need it. That risk can be even greater if they don’t have income protection insurance or private health insurance. “When you’re under mortgage stress and trying to raise a young family, paying for insurance probably isn’t your biggest priority,” Julie says.
“But if that child loses the ability to work, it could make it even harder for them to repay their debts. That could be a double whammy for parents who have already lent children money, but may need to provide even greater financial support.”
Paying for your child’s income protection insurance could be one way to protect their lifestyle, and ultimately your own. Another option might be to encourage your children to get professional financial advice.
“Helping your children save is one of the most powerful ways you can help them take control of their finances — those skills stay with you for life,” Julie says.
Five tips to make it work
1. Talk it through — make sure everyone is clear on how the arrangement is going to work
2. Put it in writing — draw up a simple legal document that outlines the terms of the loan
3. Discuss it with siblings — keep the whole family informed to help avoid future disputes
4. Insure your children — consider paying your children’s income protection premiums
5. Help your child plan for the future — encourage your children to seek financial advice
1 Majority of first home buyers now use ‘Bank of Mum and Dad’ — Domain, 2 May 2018
2 Julie Steed is a Senior Technical Services Manager at IOOF. Julie supports our Private Client Advisers in complex technical areas including superannuation, estate planning and self-managed superannuation funds.