A top guide to the Bank of Mum and Dad loan agreements

The use of the Bank of Mum and Dad is on the rise, but how do we set these lending relationships correctly to save heartache down the track?

It is crucial to understand how to legally protect a gift, loan or advance and mitigate against the risk of something unplanned occurring in the future, such as a business failure or relationship breakdown.

If you’re thinking of lending money to your children to buy their first home or borrowing from your family, there are some key considerations to keep in mind.

Pros – From Mum and Dad’s (the lender) point of view

• You can help your kids now, rather than waiting to help them after you’re gone (and hopefully, by then, they won’t need your help!)
• Your kids get a first step in the rising property market earlier than if they waited until they had saved a big deposit on their own – while they’re saving, the price of a home just gets further and further away.
• You can make flexible decisions about what you lend and at what rate the borrower pays you back as you choose. That is much different from a bank bound by strict lending rules.
• If you agree, you can still get interest on your loan so that you get some return on the investment, given that you are taking the money out of your retirement savings to give a helping hand.
• If you do things correctly using asset protection and securing the loan you’re giving against the purchased home, you can be sure that you can eventually get the money back, just like a bank mortgagee does when a house is sold.

Pros: From the borrower’s point of view

• You get into the property market sooner because you’ll have easier finance which is great if you’re struggling with the “deposit gap,” spending money on rent instead of saving your deposit money.
• You can make flexible agreements about repayment or the interest that is charged that a bank simply can’t give you because of the strict lending rules that banks have.
• You can more easily talk to your parents about varying repayments in the future if you fall on hard times or your circumstances change.
• If you’re ready and your parents are ready, you’re good to go to that auction and bid (but make sure you stay within your agreed budget!)
• If you do things correctly using asset protection lawyers and securing the loan against the purchased home, you can be sure that you can always pay other parties back. When the house is eventually sold, everyone knows what the deal is and that clarity should mean there are no bad feelings at the end.

Cons: (From everyone’s point of view)

• You still have to treat this like a business deal! The ‘bank of mum and dad’ loan agreement has to be clearly described in writing and each party has to get independent legal advice. Sadly, just a handshake and a hug aren’t good enough. Using Asset Protect you can be sure that the agreement will be enforceable, recognised by Courts and that the loan is secured against the home.
• If you don’t cover all the bases, then it can cause issues within the family when one day you no longer agree about what the terms of the loan were (such as when it was going to be paid back).
• If you don’t cover those bases and it’s all just “a handshake deal,” then if something terrible happens (like the borrower goes broke or there is a family law breakup), a Court may not recognise the loan as enforceable, and the lender might lose all their money.
• Suppose the loan is not done properly and is not secured and something terrible happens (like you lose your job or business because of an economic disaster beyond your control, as we have seen with COVID-19 lockdowns). In that case, Mum and Dad lenders will stand “in the queue” with all the other unsecured creditors hoping to get a few cents in the dollar when the house is sold to pay all the debts; they will have no priority.
• If you haven’t done the loan correctly and each party does not have independent legal advice, then one day, if disaster comes, a Court might set aside the loan as unenforceable simply because the borrower (or their spouse) didn’t have independent legal advice.
• If a disaster happens, that can sour the relationship between parent and child forever, particularly if retirement savings are lost to misadventure.

Some important things to remember:

• Don’t lend more money than you can afford, don’t borrow more money than you can afford – be careful because it is a risk and you need to minimise risk!
• Remember, if you lend money to one child, then the other kids might come looking for a loan too. Don’t create family disharmony by overcommitting to one child so you can’t help the others when the time comes.

To provide certainty and address the above list, the best protection is to have a clearly documented ‘bank of mum and dad’ loan agreement and take security against the property when lending to family members, so everyone gets independent legal advice.

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