The best ways to loan your adult kids money
22 Mar 2023
Crazy statistic: the Bank of Mum and Dad (BOMD) is Australia’s ninth biggest mortgage lender. In fact, a whopping 60 per cent of first home buyers rely on their parents to enter the property market. And mortgages aren’t the only loans BOMD are issuing – cars and travel are frequently funded as well.
Despite how common it is, it can still be quite confronting when your adult children ask for money. While it feels good to help our children out, financially enabling them is not something to take lightly.
Firstly, it’s important to carefully consider the reason for their request and whether it’s a one-off. It’s one thing to help them fund their first home, quite another if your child is repeatedly asking for money. If it’s the latter, there may be underlying lifestyle issues you can help them address instead of financing their latest blow-out.
Next, be sure that the amount your child is requesting is money you can afford to lend without jeopardising your own financial situation. It helps to be honest and upfront with your child about your finances. Sometimes adult children fail to realise that parents also have ongoing expenses and financial commitments; it’s not just a case of being the ‘mean parent’ who won’t give them a loan.
This raises another pertinent point. Loaning the kids money can come with huge risk, and not just on a monetary level. Opening a branch of the BOMD can quickly sour your relationship with your children – especially if repayments are slow and definitely if you're lending money to one child and not the other/s.
So, whether you’re contemplating a gift or loan, purchasing a property together as co-owners, or going guarantor, you need to reduce the risk to both your finances and your relationship. Here are some tactics you can use to keep the BOMD afloat.
1. Become the bank for real
If you agree to the loan, treat it as a business transaction and create a formal loan agreement. This will set out the terms of the loan, such as the loan amount; whether you will charge interest on the amount; the timing and amount of repayments and any other obligations under the loan. It’s a good idea to seek legal assistance to correctly draft and sign this agreement.
2. Limit your liability
When you act as a guarantor, things can so easily go wrong. Remember, if for any reason your child can’t make their repayments, you are responsible for paying back the loan. If you can’t afford the repayments, the lender can take any assets you put up as security for the loan (commonly, your own home).
For this reason, when you agree to go guarantor, it's prudent to limit your liability to a fixed amount that you can afford to repay in full. You can also request to limit the time for which the guarantee will be valid. If the lender won’t agree to give your child the loan under the terms you are comfortable with, it’s not the right loan.
3. Be mindful of gifts
Even if you can afford to give money to your children without a loan, think twice before you do so. If your child is in a marriage or de facto relationship that ends, your gift will generally be considered part of the family assets. A formal loan, on the other hand, may not be.
4. Set up a trust
A family trust may be a good way for you to protect your assets while still supporting your children. Family trusts are not difficult to set up, but they can be a complex tax obligation so it's best to seek qualified professional advice before you tackle it.
5. Be wary of joint purchases
Jointly purchasing your child's first home is fraught with minefields, so make sure you're both clear on your obligations as either tenants in common or joint tenants.
Firstly, know that you're liable for the full amount of the loan if something goes wrong – not just half. That goes for your child too if you can't keep up your own repayments.
Secondly, your child has a whole unknown future ahead of them, so map out exactly what you'll do if one of you wants to sell the home, but the other doesn't. Your own financial priorities may change as well, so this works both ways.
Finally, there are capital gains tax (CGT) considerations to jointly purchasing a home for your child to live in. When it comes time to sell the house down the track, your child is exempt from CGT because the property was their principal place of residence. Unless you moved in with them (a story for another day), that won’t be the case for you. For this reason, a loan arrangement is generally a more financially savvy way for parents to help their child buy a home.
All articles are general in nature. Individuals should seek expert advice before acting on any information contained in Active Retirees.
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