With the high cost of living in Australia and the rise in house prices in recent years, it is increasingly common for parents to lend money to their children to help them get a start on the property ladder. While this is great in the short term, in the longer term that money is at risk from a number of different sources. Given that more than one in three marriages in Australia ends in divorce, one of the greatest risks is a family law claim by your child’s ex-partner.
There have been some recent court decisions that serve as a timely reminder of the risks inherent in lending money to children who subsequently go through a marriage breakdown. In this article, we set out some issues to consider when lending money to your children.
Realistic loan terms
Legally speaking, there is little use in having loan and mortgage documents prepared that you intend to put away in a drawer and ignore. If you think the loan terms will not be adhered to or enforced, or the security will not be registered, you should either revise the terms to reflect this, or consider a different approach.
For example, an ‘equity loan’ structure is often far preferable to a typical ‘interest and principal loan’, because most children do not make payments of interest and capital repayments to their parents (and most parents do not enforce such payments).
If you are using a mortgage document to secure the loan, and don’t intend to register the mortgage on title, then you should agree that registration will only occur if certain trigger events arise. For example, on the breakdown of the relationship or the death of one of the borrowers.
Consistency of intention
If the money is intended as a loan, that intention needs to be clear across the board. This means that there should not be any inconsistent statements of intention made to anyone else, especially a Government authority or a bank.
If the money is being used to purchase real estate, your children may wish to rely on the money as part of their initial ‘equity’ (i.e. deposit), to enable them to get a bank loan for the balance. However, if your kids represent to the bank that the money ‘is theirs’ then this will contradict the loan arrangement, i.e. it is more likely to be seen as an outright ‘gift’. It is now very clear that the courts will take into account not only what is in the document, but what you say to the bank!
In addition, most banks have tighter restrictions around lending money to people who are expecting to have a second registered mortgage on title. If you can afford it, then you will be in a much stronger position to enforce the loan if you lend the full amount to your child, i.e. if a bank is not involved. This way, your loan security can be registered over the property without fear of triggering a default of a bank’s loan terms, (and you will not be making any statements to the bank that are inconsistent with your private loan arrangement).
Independent legal advice
When looking to enforce a loan, it is crucial that you can demonstrate that the borrowers had a clear understanding of the loan terms and the consequences of default or non-payment. To show this, the borrowers (including your child-in-law) should obtain independent legal advice about the loan prior to signing any documentation. This will go a long way to ensuring your loan is enforceable.
You should also ensure that all borrowing parties are involved in the discussions and documentation regarding the loan. For example, if your child’s spouse is kept out of the loop there is a risk that a Court will later find that the loan is either not genuine (and therefore not enforceable), or that the loan is an unjust contract. A tailored and easy-to-read loan agreement that all parties are signatories to is the ‘gold standard’ in this regard.
Binding financial agreement
A legally binding way to record the requirement to repay a loan in the event of a marriage breakdown is using a binding financial agreement recognised under the Family Law Act.
The Family Law Act allows couples at any stage of a marriage (i.e. before, during or after) to enter into a binding financial agreement to record how, in the event of the breakdown of the marriage, all or any of the property or financial resources of the couple are to be dealt with. This means that your child and their spouse could enter into a binding financial agreement to agree that, if their marriage breaks down, their property is to be sold and your loan repaid.
Because the Family Law Act provides that binding financial agreements are binding and enforceable in most instances, this provides good legal footing for you to ensure your loan is repaid. The downside of a binding financial agreement is that it can be a costly exercise, because both parties must obtain legal advice about the agreement. However, in the context of lending your children several hundred thousand dollars, the cost is usually a small expense compared to the value of the loan money at stake.
Consider taking an ownership interest
As an alternative to a loan, you should also consider acquiring an ownership interest in the asset commensurate with the funds you are providing. That way, rather than lending the money, you have a defined legal interest in the property. This puts you in a very strong position to extract your money out of the property if family law issues come into play.
When all is going well, you can allow your child and their spouse to live in the property rent-free. You would just require them to pay the expenses associated with the property and make any mortgage repayments relating to borrowings they may have taken out to finance the purchase.
Having your name on the title to the property gives you far greater rights than as a lender. If your child’s marriage breaks down, you can agree to sell up and realise the value of your interest in the property. If things turn nasty, as a tenant-in-common owner you can apply to the Court for an order for the sale of the property. It is also a good idea to put in place a simple ‘Co-owners Agreement’ to regulate how the property will be owned and when it will be sold.
Lending money to children is not straightforward, and legal advice upfront about the risks and best strategy will help protect your money. Some short-term planning can avoid you waving goodbye to your money together with your ‘child-in-law’.
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