Helping the family — without a feud
Lending to your children can help everyone, if you do it right
We retired about seven years ago and planned to enjoy a comfortable ( not lavish) lifestyle on our superannuation, augmented by interest gained from nest- egg bank deposits. In recent years we find that deposit rates have diminished to the extent that we are now in a negative income/ expense situation.
In the meantime, our children have entered the housing market and taken on a mortgage from their own bank.
So why could we not arrange a loan at an interest rate below ruling bank rates for our children, which would give us a better return on our investment while also providing them with a favourable mortgage repayment schedule?
Clearly, our interest would still be regarded as taxable income, and some legally binding documentation would be necessary to secure the loan. And savings for both parties may not be huge, but it still seems like a winwin. Or am I missing something?
Just complexity. Eight years ago, in this column, I replied to someone who was thinking of borrowing mortgage money from their in- laws. It’s the same situation as yours, but from another perspective. Here’s how my reply started: “It’s time for a family conference, at which you would need to discuss all of the following gloomy possibilities: What would happen if you or your spouse — or even both of you — lost your jobs or had health problems and were unable to make payments to the in- laws for a period? Is it possible that someone could sue you or your spouse and you lost your house? If that happened, what would you do about your debt to your in- laws? What if your marriage ended and you wanted to stay in the house while your spouse moved elsewhere? Would your in- laws be willing to leave their money in the house? If not, would you be in a position to get a new mortgage? What if your in- laws decided, after a while, that they wanted to spend the money, perhaps on a health problem or family financial crisis? What would happen if you or your spouse died, or one or both of your in- laws died, while the loan was still outstanding? “All of these i ssues could be addressed in a contract. But before you go to a lawyer, it would be wise to make sure you all agree about how they would be handled.”
The same applies to you and your family. If you find any of this difficult to discuss now, it would be even more difficult when things go wrong.
Another important point: try to involve all your children in the discussions. If you don’t want to treat them all alike, explain why not, and make sure everyone accepts that. Otherwise this is the stuff that can start lifelong family rifts.
You might also want to discuss adjustment of your wills and those of the recipients of loans. For example, if you both die before the debt is paid off, the amount of the loan could be deducted from that child’s inheritance. And if the recipients die, you might want to stipulate that the debt to you should be repaid from their assets.
And be sure you agree on how you will handle changes in mortgage and term deposit interest rates. If they all rise, for example, will the interest you charge also rise? And specifically which rates will you use in these calculations?
Once everyone agrees on all these points, it’s important to put everything in writing, and for everyone to have copies signed by everyone else. While you could do this yourselves, it’s wisest to involve a lawyer — especially when it comes to thorny issues like what happens if a borrower’s relationship breaks up.
One service to consider is offered by Family Loans. Run by two former Deloitte partners, the company organises and registers loans between family members.
On its website, www. familyloans. co. nz, most of the information is about loans from adult children to their elderly parents, in a sort of variation on a reverse mortgage. “But we’re doing more on the other side now” — loans from parents to adult children, says managing director Paul Frampton.
The company will take care of the legal set- up, for a fee of $ 2000, or you can use your own lawyer. Then, for an ongoing $ 300 a year, it runs a registry that keeps track of who owes what and payments made. You decide which family members have access to the registry.
Family Loans has expertise in such issues as making sure all children get equal treatment, says Frampton. For example, if parents make an interestfree loan to one child, the company will calculate what’s called the notional interest. Then, after the parents die, inheritances can be adjusted to reflect that favourable treatment. In effect, the interest i s paid at that stage, to be fair to the other children.
Got all that? This is not as simple as it first seems. And, as you say, the gains might not be all that big.
Let’s say you receive 4 per cent on your bank term deposits, and your daughter pays 6 per cent on her mortgage. Instead, you lend her $ 100,000 at 5 per cent. You make $ 1000 more a year before tax, and your daughter pays $ 1000 less in interest each year.
But if you lend her $ 300,000, there’s $ 3000 in it each way, at least before tax. It starts to get to be more worthwhile.
Done properly, loans between family members can benefit everyone. It’s up to you to weigh up the pros and cons.
PS: Can I tease you about your wording: “We are now in a negative income/ expense situation”. Would that be a. k. a. “We spend more than we earn”?
Inspiring example
My wife and I recently paid off our house in Auckland ( Grey Lynn/ Western Springs). We bought it seven years ago for $ 525,000 after saving a 20 per cent deposit while renting. Our household income was $ 150,000 to $ 160,000 per year pre- tax before kids ( a 2- yearold and a 2- month- old), and about $ 100,000 after they were born.
We had no financial help from parents ( although they offered). But both of us have a good saving record, basic spending discipline and budgeting skills. And we were focused on paying off debt rather than having nice cars and new phones, and shopped around for everything ( including banks — brand loyalty is for suckers), with the view that any extra dollar we could put into the mortgage would be worth two dollars later on.
We still went on holidays overseas and out for dinner, but those things were rewards for achieving goals rather than the default option.
We also used the equity we had in the house to buy a rental property in Sandringham three years ago ( after six months of looking and going to auction), which now pays for itself, and things are looking good.
I have been tempted for a while to write a letter about our situation to let people know it’s not impossible to do well on average/ OK income, but it’s hard to write about without sounding preachy and smug. We are proud of it though.
So you should be. And given that nobody knows who you are — except perhaps some friends who might recognise you — you can’t really be accused of showing off.
Someone once said, “wealthy people miss one of life’s greatest thrills — making the last car payment.” And making the last mortgage payment is an even greater thrill.
There’ll be readers who bought Auckland houses recently, or are trying to buy, who will say, “It’s all very well for them. They had to spend only half a million dollars.” But still, they could do much the same as you but over 15 years instead of seven.
Thanks for writing. I’m sure your example will inspire others.
Not enough credit
My husband and I are in joint accounts with savings of $ 400,000 in term deposits. The interest received and my salary are our only monthly incomes, totalling $ 3000 a month. We have zero debt and pay off our credit card balance every month.
Our $ 400,000 term deposits and credit cards are with ANZ. My weekly salary is banked into an ANZ account as well.
We would like to go on holidays and tried to apply to increase our credit card limit from $ 10,000 to $ 20,000, but were told it is not possible because my husband is the principle card holder with no earnings. I’m a designated holder.
Increasing our credit card limit to $ 20,000 is just 5 per cent of our cash $ 400,000, and ANZ refused our request.
Who is the financial authority that makes such stupid regulation?
It is absolutely annoying and upsetting! We are so frustrated and hope you could raise this matter in the press.
This makes a change. I’ve heard several complaints that a bank has extended a person’s credit card limit beyond what they — or someone concerned about them — thinks is desirable. Some people don’t want to be tempted to spend more. And some parents worry when their student offspring are given credit cards with limits of several thousand dollars.
This has given me the impression that banks are only too keen to extend credit card limits. But evidently not always.
ANZ responds to your letter: “In general, we only consider the primary cardholder income when assessing affordability. However, we also recognise that there are circumstances which might mean a higher credit card limit is appropriate. We’d suggest that customers who need a higher card limit talk to us.” Time to get on the phone. Your case sounds pretty solid to me. And perhaps ANZ should make it clearer — when turning down requests like yours — that it’s open to discussing this.
By the way, no financial authority is involved in decisions like this. Each bank is allowed to make its own decisions on how much credit it extends.
Don’t forget tax
I enjoy reading your column with interest each week. While I appreciate you are restricted by word count limits, your answers often omit an important issue — tax.
By way of example, in last week’s column the $ 230,000 UK share portfolio held by the couple wondering whether to sell the shares and pay down their mortgage is very likely to be subject to the foreign investment fund tax rules.
Surely, some comment should be included in your answer noting that the tax treatment of holding the portfolio and possible disposal should be taken into account?
From my experience as a tax adviser, many people with such investments do not consider the NZ tax implications of holding the investments until they receive a letter from the IRD!
Fair enough. Generally I like to assume that readers are paying the correct tax, when that’s not what their question is about. But if you’ve found this to be an area where ignorance is common, it’s probably good that you have drawn the couple’s attention to it by writing in.
If they don’t know about this tax, they might want to do a Google search on “foreign investment funds”.
Mary Holm is a freelance journalist, a director of the Financial Markets Authority and Financial Services Complaints Ltd ( FSCL), a seminar presenter and a bestselling author on personal finance. Her website is www. maryholm. com. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to mary@ maryholm. com or Money Column, Private Bag 92198 Victoria St West, Auckland 1142. Letters should not exceed 200 words. We won’t publish your name. Please provide a ( preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice.