By Peter Nevile
The Bank of Mum and Dad has become a significant source of lending. Ever-increasing property prices have made it more difficult for young people to buy a property. They often lack a sufficient deposit or income for banks to approve a loan. Alternatively, the loan repayments may place them in a precarious financial position.
This is an increasingly common situation where the Bank of Mum and Dad comes into play. They seek to assist by contributing to the deposit, enabling their children to qualify for a loan or simply to provide an amount on which little or no interest is payable, so that repayments of the prime loan to the lending institution are manageable. A noble and worthy act. However, it does not come without significant risks.
Two songs spring to mind, the first by Cindy Lauper, “Money Changes Everything”, and the second by Tina Turner, “What’s Love Got to Do”.
We have seen rising tensions, arguments, court actions, and, worst of all, estrangement between parents and children.
Here are some of the issues:
1. Given the present divorce rate, parents are concerned that the money they provide for their children remains in the family and does not become a subject of a divorce settlement to a third person. Binding financial agreements (‘prenups’,) can assist. However, many young people in the throes of love find this topic awkward to raise. They are not inexpensive, as each party requires independent legal advice. To avoid those situations, it is important that frank and open discussions are held, the potential issues discussed, and formal agreements are entered into to avoid misunderstandings or disputes in the future.
2. The loan should be treated in the same way as a commercial transaction. That requires documenting the loan and registering it preferably as a second mortgage behind the prime lender, such as a bank.
3. We have seen situations where parents do apply an interest clause but defer the payment of interest until some later date. That can create issues with the parents being liable for tax on the interest to which they are entitled that year.
4. There are also potential issues where parents reduce their capital to the point where they may not have enough to provide for future unexpected expenses.
The Bank of Mum and Dad plays a very useful role. However, to avoid potential heartbreak, we strongly recommend that it be treated on a strictly commercial basis. All parties should be advised to seek independent legal advice.
Please do not hesitate to contact us for a confidential discussion. Family disputes and even estrangement create great sadness. They can generally be avoided with proper processes before a loan.
Disclaimer: This publication contains comments of a general and introductory nature only and is provided as an information service. It is not intended to be relied upon as, nor is it a substitute for specific professional legal advice. You should always speak to us and obtain legal advice before taking any action relating to matters raised in this publication.
