It is quite common for parents to lend significant amounts of money to their adult children to help with expenses like buying their first home. Money is often lent by parents with an expectation that it will be repaid sometime in the future, but no steps are taken to formalise the loan. There is nothing in writing, no payment schedule and nothing secured against the loan. The loan relies on the trust and relationship between the parent and child.
Whilst borrowing from the “Bank of Mum and Dad” can certainly be an attractive option for children compared to borrowing from a normal bank, problems can arise in the future if, for example, the adult child has a relationship breakdown, or a parent loses capacity. In the first of this two-part series, we discuss the potential family law issues involved when parents lend money to their adult children.
Is it a loan or a gift?
If the adult child is married or in a de facto relationship when the funds are lent, and the marriage or relationship later breaks down, the issue of whether the money was advanced as a loan or a gift can become contentious as it may have a significant impact on the asset pool available for distribution between a child and their former spouse.
If the Court deems the payment of funds a loan, then it is a debt of the relationship which needs to be repaid from the parties’ asset pool before the remaining assets can be distributed. If the Court deems it to be a gift, then the funds forms part of the asset pool available for division, which means that the parents will not be repaid under any Family Court order.
The child whose parents advanced the money will naturally assert that it is a loan to be repaid from the asset pool whereas their former spouse/partner will maintain that the payment was a gift from the parents. The parents could find themselves dragged into their child’s property proceedings in the Family Court and have to incur considerable legal fees to recover their funds.
How does the Court determine if money is given as a loan or gift?
The Court will consider all of the evidence surrounding the payment of money including some of the following factors:
- Was there a written agreement setting out the terms of the loan?
- Have there been any demands for repayment?
- Have any repayments in fact been made?
- Whether and when interest is payable?
- Is the loan secured?
What should parents do if they want to loan money to their adult children?
If parents are considering lending money to a child who is either married or in a de facto relationship, we strongly recommend they obtain legal advice and undertake the following steps:
- Enter into a written, signed loan agreement which sets out the terms of the loan. It is important that this is done prior to lending the money, rather than later down the track when difficulties in the child’s marriage or relationship have already arisen.
- Consider having the loan secured against the child’s assets. For example, a registered mortgage against real estate owned by the child or a registration against their personal property on the Personal Property Security Register.
- Ensure that the terms of the loan are adhered to, i.e. regular and ongoing repayments are made, payment of interest etc. Payments need to be made well in advance of any potential separation. If payments are not made until after a couple separates, the Court may view this as an attempt to reclassify a gift as a loan simply for the purpose of a property settlement.
- Document formally any changes to the loan agreement due to the child’s lack of ability to repay the loan on the due dates
Look out for part 2 of our series where we discuss the potential estate planning issues that can arise when parents lend money to their adult children.
For more information, please contact a member of our Family law team at Fox and Thomas.