Despite the recent drop in home prices, it is still difficult for many young people to buy their first home. Nowadays it is quite common for young buyers to approach the so-called ‘Bank of mum and dad’.
If parents have the financial capacity to help their children to purchase a home, then it can be an excellent way to benefit their children without the children having to wait until their parents pass away. Whilst receiving an inheritance later in life is good, in many cases the beneficiaries were in greater need of the financial assistance when they were much younger.
In providing the financial assistance there are some legal aspects to consider. The following case study explains the issues.
Norm and Nancy have two children, Greg and Rhonda. Consider the following issues.
- When Greg married Susan, Norm and Nancy gave Greg the sum of $200,000 to assist he and Susan to buy their first home. Ten years later Greg and Susan divorced. The question then arose as to the status of the advance. Was it a gift or was it a loan? Greg argued it was a loan, and Susan said it was a gift to both she and Greg. If it was a loan, then Norm and Nancy could ask for the return of the funds, so that Susan didn’t get the benefit of half the advance. There was no written evidence, one way or the other. The usual approach of the Family Court is that if there is no written evidence the Court is likely to decide the advance was a gift. Therefore, Norm and Nancy could not demand the money back.
- About the time Greg and Susan separated, Rhonda married Paul. Norm and Nancy wanted to provide financial assistance to Rhonda, similar to what they had done for Greg. To avoid the same issue if Rhonda and Paul separated, they got Rhonda and Paul to sign a note acknowledging that the advance of $200,000 was a loan, repayable on demand. When Rhonda and Paul separated ten years later, Norm and Nancy asked for the loan to be repaid. Paul’s lawyer advised him that the loan did not need to be repaid. The reason being that the loan became ‘statute barred’ six years after the loan was advanced. This was because of legislation which provides that if a loan is made ‘repayable on demand’ and if the lender doesn’t ask for the money back within six years from the date it is advanced, then it cannot be recovered.
So, what should Norm and Nancy have done to protect their children? The key points are as follows:
- Make sure there is a written agreement stating the advance is a loan.
- Provide a definite repayment date. That can be something like 30 years, but with provision for an earlier date being on say three months written notice. That means that if a separation occurred after 10 years, the lenders could then give the required earlier notice of three months.
- Whilst the agreement does not need to include an interest provision, it should include an obligation to make some annual repayments of capital, which can be nominal, such as $100 per annum.
- Whilst there does not need to be a formal mortgage agreement, Norm and Nancy should get some legal advice to ensure the written loan agreement is enforceable after the statutory period of six years.
This article was first published in Personal Wealth Adviser – Issue 4.