The bank of mum and dad – and the kids
Beware baggage when lending to family members, writes
Asset rich, cash poor. It’s a financial predicament many older people face, living in a valuable house, but struggling to make ends meet.
Some resort to high interest reverse mortgage loans which puts money in their pocket, but erodes their equity.
Two former partners from tax and accounting firm Deloitte think there’s a better way; helping professional people lend to their cash-strapped parents.
Paul Frampton and Paul Gadd’s Family Loans business helps families arrange properlydocumented inter-generational loans enabling families to keep interest-hungry banks out of the loop.
Family loan types
It is common for different generations within a family to help each other.
Parents sometimes guarantee a portion of their children’s home loans to help them avoid lowdeposit levies and inflated interest rates.
Gifting, or lending, the children a house deposit seems the only way parents can be assured their young ones don’t miss out on owning a property.
Money can go sideways, too, with sibling lending to sibling, sometimes in emergencies.
We’re so long-lived these days, loan flows can even skip generations, with grandparents lending money to grandchildren.
But increasingly, Frampton says, people are lending money to their cash-strapped parents, to be paid back from the estate after they die. Family Loans’ focus is on helping families arrange this kind of loan.
Familial lending is a littleunderstood phenomenon.
It is roughly known how many loans between family and friends are being made, but not the amounts, or what the money is used for. The chances are that most loans are small.
A 2014 report on financial inclusion, paid for by National Australian Bank (the parent bank of BNZ), indicated about 5 per cent of Kiwis at any one time have a loan from a family member or a friend.
Internationally, that’s quite low. It was 25 per cent in The Netherlands and 12 per cent in Australia.
How to make family loans
Lending within the family can lead to trouble, Frampton says.
Family Loans offers loan contracts families can use when one family member lends a substantial sum to another. It has also set up a digital loans register and developed a software program which allow lenders and borrowers to manage their loans.
The idea for Family Loans came from a chat with Frampton’s family lawyer, who had been preparing a loan contract for an inter-generational family loan for another client.
That suggests at least some family loans are being documented by lawyers, though it is likely to only be for the larger ones.
‘‘One of the major issues that arises within families is the potential disruption to family harmony through loans that are not properly recorded or even known by other family members,’’ Frampton says.
Frampton helped develop the business case for the creation of state-owned Kiwibank.
Gadd says: ‘‘We provide peace of mind to the lenders, borrowers and other family members and loan terms can be anything agreed between the family members.’’
‘‘It doesn’t matter whether it’s a loan from parents to children or vice versa. A key point is that children who lend to parents are protected as the home is security for the advance and parents retain life-time occupancy of the home.
‘‘In fact, although we see the major application is between family members, the registry system can just as easily work between friends.’’
Fees and interest
The subject of charging interest can be a vexed question.
The system developed by Family Loans allows notional interest to be ‘‘recognised’’ and recorded.
‘‘Only when the loan is eventually repaid will the notional interest be recognised as actual interest and paid to the lender,’’ Frampton says.
‘‘At that time, resident withholding tax provisions will be triggered.’’
By contrast to loans from banks and finance companies, interest charged on family loans is likely to be low, often just enough to preserve the value of a lender’s money.
Indeed, family loans may be arranged in a bid to avoid family wealth leaking away to bank and finance company shareholders.
Interest on commercial reverse mortgages can add up to large sums.
Heartland’s current floating interest rate is 7.6 per cent. On a $50,000 loan, more than $56,000 of interest would accrue over 10 years, if the rate remained unchanged.
That may be acceptable if house prices continue to grow, but if they don’t, then equity can be eroded.
‘‘One of the only alternatives available to them (asset rich, cash poor older people) is to take a reverse equity mortgage, which can result in crippling charges that decimate the eventual inheritance for children,’’ Frampton says.