Over the last few years, the ‘Bank of Mum and Dad’ has become one of the largest lenders in Australia. One of the most common ways this happens is through guarantor loans for purchasing a property.
In 2021, 60% of first-home buyers turned to their parents for financial assistance to make their property dreams a reality. Whether this was through their savings or their equity on their existing property, in total, the Bank Of Mum and Dad loans account for $34 billion put towards first-time homes across the country.
As parents financially help their children with home deposits, with their contributions averaging more than $89,000, parents need to ensure they are not putting themselves at additional financial risk.
Protecting The Loan In Case Of Divorce
There has been increased concern from parents wanting to safeguard and protect monies provided to children during this time due to the rising interest rates, increased mortgages and higher risks of defaulting on a loan. This is especially true if loaning to a child and their partner; in the event of the relationship’s potential breakdown, how is the loan safeguarded and protected?
One of the safest ways to protect any money provided between family members is via a written financial agreement.
Financial agreements enable parties to regulate their financial relationship in the event of separation, giving them more control over financial decisions. These agreements can be made before a relationship commences, during or at the end of it.
Parents often require their children to enter into a financial agreement with their spouse as a condition before the provision (whether as a loan or gifted) of monies for a property purchase.
Another way is to provide clear documentation of the money provided between the parties involved (the parent/parents to their child and their child’s partner). This can be done through a written loan agreement, which a solicitor should preferably draft.
A loan agreement should contain the following terms and conditions (at minimum):
- The amount of money loaned;
- The purpose or intention of how the loaned monies will be used;
- Interest rate;
- Term of the loan (the duration);
- Repayment schedule; and
- Security for the loan.
It might be awkward asking for a “loan agreement” from your child and their partner, but in case of any future relationship breakdown, it will save a lot of heartaches.
What Happens To The Loan In The Event Of A Divorce?
If the child divorces their partner, the settlement must consider your “Bank Of Mum and Dad” loan to the pair.
In very simple terms, the first step is to work out the total value of the property, and second to determine the percentage that it should be divided by, considering each spouse’s contributions.
The treatment of financial support may depend on the context of the support, whether it was considered a loan or gift, and whether it was intended to benefit both parties or just one person.
If the funds were given as a gift, it would be treated as a contribution by the person who was given the gift and will be taken into account when determining the percentage of the assets to be split.
Courts will look for some formality in a loan agreement, including documentation, whether there was a repayment plan in place, if there had been any demands for repayment and if any interest had been charged.
Most family loans are informal and don’t have this level of detail available, making claiming the funds were “a loan” much more difficult. Even though lending money to family or giving it as a gift is a common practice, it’s vital to ensure the circumstances are well documented.
This area is fraught with potential complications - it is best to seek the advice of licensed professionals and advisers (such as mortgage brokers, financial planners & legal advisers) before assisting your children with a Bank Of Mum and Dad loan.