Loan Agreement Considerations When Borrowing from the Bank of Mum & Dad
With the world in the midst of a pandemic and many economies facing recession, financial pressures continue to build especially for young families. Now more than ever, children are turning to the bank of mum and dad for assistance with purchasing homes, paying down debts or getting themselves out of financial difficulties.
Parents often feel obliged to assist their children, particularly where their kids have lost their jobs, have young families they need to provide for or where one child is at a financial disadvantage to their other siblings.
Prior to providing financial assistance to children, parents need to be clear on whether they intend for any such assistance to take the form of a gift or that of loan.
It is common for disputes to arise in respect of financial assistance where the child:
- becomes involved in Family Court proceedings and their spouse claims the monies were a gift to the marriage/relationship,
- decides to dishonour agreements made with their parents due to a breakdown of the relationship,
- becomes bankrupt and their trustee in bankruptcy seeks to have the funds classed as an ‘asset’ instead of a ‘liability’, or
- tries to depart from the agreement upon the death of the parents, leading to disputes between siblings and other beneficiaries.
Where disputes arise, it is usually the parent or the parent’s executor who has to prove that the amounts advanced to the child were a loan and not a gift. This is where a clear paper trail and properly prepared and executed loan agreements are particularly important. Unfortunately, often there is little or no documentation and the parents have had no advice from a lawyer beforehand.
If you are a parent looking to provide financial assistance to your children, here are some things for you to consider:
- Ensure the loans are acknowledged in writing by both the child and the child’s spouse/partner. This makes it harder for a child or spouse to renege on the agreement later.
- Ensure that the child makes at least some repayments of the principal or pays interest annually. This will help to confirm the arrangement as a loan.
- Consider taking security over the loan, such as a mortgage or a caveat. This will better protect you should a dispute arise involving a spouse or creditor. If your loan agreement is not secured, in the case of bankruptcy, you will be just another unsecured creditor and may never be repaid.
- Update your estate planning documents to ensure that they reflect your intentions regarding the loan. Will it be forgiven on death? If so, will the other children be compensated with a greater share of the estate?
- Ensure your accountant, advisor, executors and attorneys are aware of the loan and your intentions regarding the repayment or forgiveness of the loan.
- Consider what is to happen with the loan if your child dies before you.
- Seek advice as to who ought to lend the monies. Will you lend personally, or will an entity associated with you lend the monies?
- Seek advice on the tax implications of charging interest under a loan. Where interest is paid, this will be income to you and you need to be clear on when you need to account for this in your tax returns.
At Lynn and Brown Lawyers we often assist parties to implement loan agreements and advise on any issues arising from existing arrangements. So if you would like to discuss a new or existing loan arrangement with us, please contact Karolina Rzymkowska on email@example.com or call 08 9375 3411.
About the author:
Karolina Rzymkowska is a Perth Lawyer and Head of Estates at Lynn & Brown Lawyers. Karolina leads the Estates Team and is highly experienced in both simple and complex estate planning, estate administration and disputed estates.