Houses are expensive. Many parents are wanting to help their adult children to enjoy the benefits of homeownership for financial security and family stability. This leads many parents to explore options for assisting their children to buy a home. Let’s consider some of these options.
Parental loan or gift
Is it a loan or a gift? Make it clear from the outset. If it’s a loan, then an agreement should be prepared to ensure that the terms of the loan are clear and that with the passing of time the loan is not misinterpreted as a gift.
Often a loan to a child will be interest free and repayable upon demand. Legally, there can be issues with a long-term loan that is repayable upon demand. Legislation can impose a limitation period for unsecured personal loans. For example, in New South Wales this is six years, after which the loan may become unenforceable.
In the case of a gift, declaring that in writing may help the child to obtain finance as lenders will often seek assurance that there are no future repayments required. It will also reduce the risk of a potential estate dispute in future.
When providing a long-term loan or gift the opportunity cost of having that cash invested can be substantial over time. This can impact the income of the parent and their lifestyle.
If the parent receives Social Security benefits such as Age Pension, the loan will be assessed as an asset in a similar way to if the funds were held in the bank. Even if the parent makes a gift to the child, gifts over $10,000 in a financial year count as a ‘deprived asset’. This means that it counts as an assessable asset for Centrelink for 5 years.
In the event of the child experiencing a divorce, a gift may end up being split with the spouse. A loan may give some protection from this occurring.
What happens if the parent dies? If the loan has not been repaid, how is it considered when the parent’s estate is divided. What impact will this have if there are multiple children who have received different financial benefits throughout the parents’ lifetime? Will there be adequate other funds to allow the estate to compensate other family members?
Don’t underestimate the consequences of providing unequal financial assistance to siblings. Being fair does not always mean being equal, however these things can simmer on the back burner for many years before becoming a full-blown family conflict. Just because it seemed fair at the time does not mean everyone will feel that way in future.
Becoming a guarantor for a loan is a popular option for parents that are unable to provide a gift or loan.
There are risks for the parent. If the child defaults on the loan, the parent may be required to repay the full outstanding loan balance plus interest, fees, and any other penalties. Often the parent would be required to provide security for their guarantee in the form of a mortgage against their own home. Parents should also ask themselves, “if I die, will the guarantee prevent the sale of my home in order to finalise my estate?” Or “what if I want to move or need to move into aged care?”
Parent as co-owner
An alternative is parents becoming a co-owner of the property with their child as “joint” owner or “tenants in common.” Tenants in common allows the parent to own a percentage of the property. The advantage here is that rather than providing a cash gift or loan, the parent would share in the equity of the property and long-term growth. This may provide the parent with a level of financial protection.
The parent could amend their Will to leave their share of the property to the child.
Will rent be charged on the parents’ percentage of the property. What would the tax implications be for the parent? It’s likely that capital gains tax would apply when sold, as the home is not the primary place of residence. State-based land tax may also apply.
A co-ownership agreement should be signed to protect the interests of all parties including the parent, child (and potentially partner). The agreement would detail how any income or expenses of the property would be dealt with, as well is what happens if any party wants to sell. For example, the child may have first option to buy the remaining share of the property at market value if the parent chooses to sell.
There are risks here for the child. For example, what if the parent is required to sell their share due to bankruptcy or divorce? Even if they have the first right of refusal, they may not be in a financial position to buy the remaining share of the property.
Lachlan Harvey CFP®
Authorised Representative (No 227293)