All hail the bank of mum and dad
Helping the next generation into home ownership can be a legal, financial minefield
The bank of mum and dad is becoming increasingly important for younger people. For many families, it works a treat. However, helping the next generation with a deposit to get a leg on the property ladder can be a legal and tax minefield.
Last year, Consumer estimated that nearly half of all first-home buyers had help from their parents. House prices have eased since then, but it’s unlikely the figures have changed much.
A decade ago parents were often encouraged to provide guarantees to pay the loan if the children default. That works for parents who own homes, but don’t have cash to gift or lend.
Hidden in the fine print was the fact that the guarantees were unlimited.
The parents were guaranteeing any future house, consumer, or business borrowing by their child and partner or spouse.
Banks can sell the parents’ house to recoup the mortgage. They don’t even have to notify parents if the children default. Guarantees can be limited. Westpac’s Family Springboard loans are an example.
Some parents are in the position to lend or gift money towards a house deposit. The bank will want to see at least 5 per cent genuine savings by the children because it shows they’re fit people to repay a mortgage.
Pidgeon Law director Joanna Pidgeon says banks prefer money from parents to be gifts, not loans. The gift becomes equity in the home.
Loans reduce the borrowing capacity of the child because the debt to parents reduces their ability to service a loan.
If it’s a gift, the son- or daughter-in-law might pocket half the money if the couple splits. Gifts are sometimes accompanied by a “prenup”, which is an agreement to contract out of the Property (Relationships) Act. If the couple splits, then the child of the parents who gifted can extract the gifted money from the split, instead of the former partner taking half.
If it’s a loan/acknowledgment of debt by the couple, then the parents can get the money out for their child should the relationship break down, says Pidgeon.
But however the help with a deposit is provided, it’s a good idea to have a fourway discussion between the parents, their child/partner, the in-laws, and a mortgage adviser, says Pidgeon. It ensures everyone is on the same page as to contribution and intention.
The other issue is the parents’ future needs. Financial circumstances change, she says.
“For example, you had a really good restaurant that was doing well. You gifted money to your child. [Come] 2019 and Covid hits. Your restaurant goes under. You remortgage your home, and you end up entering retirement still with debt. You’re now needing help yourself.”
Loans give flexibility to require repayment should you need it, says Pidgeon.
There is also an issue if there is more than one child in the family. “[Parents] need to try to have some equivalency, if not equality,” says Pidgeon. “If there’s nothing left to help the [other children] it can create family tension.”
Family trusts can create another level of legal complexity for the bank of mum and dad. “Presuming the child’s spouse is not a beneficiary, you might need acknowledgement from the spouse that [a loan] will be repaid as a joint debt.” Otherwise the child, not their ex-spouse might be left responsible for repaying the entire loan.
Tax is also an issue that parents often don’t think about. If they lend money to the children with the expectation that interest will be paid, that’s then taxable.
Terry Baucher, director of tax consultancy Baucher Consulting, says if the loan came from a trust any interest charged would be taxable income for the trust and non-deductible for the children. “On the other hand, and this is not a tax issue, if the trust didn’t charge interest that might be seen as an incorrect application of trust funds, particularly if one of the borrowers was not a beneficiary.”
If parents buy a portion of the house, rather than helping with the deposit, they’re liable to pay tax on any capital gains if the home was sold within 10 years, or five if it’s new.
“If the parents take a direct interest in the house alongside the children then gains realised on a sale within the brightline period would be taxable,” says Baucher. “A similar situation would arise if a trust bought a part interest in the house.”
Family trusts can create another level of legal complexity for the bank of mum and dad.