The risks, rewards, and intricacies of giving your kids a helping hand
In the final part of Haigh Lyon’s first home buyer series our property team analyses the key things to consider when a parent lends money to their child to buy a home.
Increasingly, the bank of mum and dad is becoming a go-to option for many Kiwis’ looking to buy their first house because they are struggling to save an acceptable deposit as prices rise.
On top of property prices continuing to rise, the introduction of the Loan-to-Value Ratio (LVR) restrictions, and other banking requirements brought in by legislation, it has become even more difficult to obtain a loan from the bank.
Going to a parent, or parents, and asking for help is one way to potentially overcome these hurdles, and if the process is done right, it not only benefits a child’s first purchase but can help set them up for the future.
There are three common ways to structure the arrangement between parents and their children:
- Gifting funds which will be recorded in a deed of gift;
- Granting a loan to children that is recorded in a loan agreement and could be secured by a second mortgage over the property; or
- Taking an interest in the property proportionate to the share of the contribution to the purchase.
If the parent decides to gift the necessary money, the value of the gift should be recorded in a deed of gift.
It is important to note that once gifted, the funds belong to the child. This may mean that the funds, or the property the funds are invested into, become relationship property of the child and their spouse, which might not be intended by the parents.
To combat this, the child could look to use a trust structure to own the funds, although this may have limitations depending on their relationship status.
However, the best protection is for the child to enter into a “pre-nup” contracting out of the equal sharing provisions of the Property (Relationships) Act 1976 and recording that the gift from their parents is their separate property in the event of separation or death.
If a parent loans the funds, a loan agreement should be drawn up to detail the sum of the loan, the term of the loan, the repayment obligations, any interest components, and any security provisions such as an agreement to mortgage.
An agreement to mortgage allows the parents the opportunity to place a second ranking mortgage on the title of the property to protect the loan and provide the parents with security that will sit ahead of any other claims, but behind the bank. The bank’s consent would be required for this.
If the child is acquiring the property with their partner, then the loan should be drawn up in both of their names so that if the relationship ends the parents can call up the loan and be paid out of the sale proceeds. Those funds can then be released to their child to assist with their next purchase.
Investing in the property
Investing is particularly favourable for parents as it allows them an opportunity to make a capital return on their funds (particularly if they are charging little to no interest).
It is advisable in such instances to have both parties enter into a Property Sharing Agreement. A Property Sharing Agreement can be between the child and their parent, or the child, their partner, and the child’s parents.
This provides an exit strategy if one or more of the parties are not happy with the situation. It’s important to establish who pays what, in relation to the outgoings and mortgage repayments, given the parents will not be living at the home, and who is responsible for the maintenance of the property and repairs.
If the parties own the property together, it is likely the group will need to take out a joint loan. Parents need to consider whether they want to accept liability for such a loan. An alternative option they may have is to grant the bank a limited guarantee in respect of their child’s borrowings.
However, either option may inhibit the parents’ ability to refinance their own property or impact their current lifestyle if a guarantee is required.
Other factors to consider
The impact on parents and other family members
It is important that all members of the family, including any other children or de facto partners, understand the impact of the loan, gift, investment, and/or guarantee.
This is often side-lined because it can be a difficult conversation to have. However, it is essential as these decisions can have major implications such as affecting the parent’s retirement and any residential care subsidies they are entitled to.
The parents must undertake their own due diligence on the property; particularly if they want to take an interest in the property or give their child a loan. Any issues that arise with the property could end up being their problem as their child may not have the funds to remedy them.
Lending money to your child to buy a home is a great thing to be able to do if you can. However, there are potential fishhooks to negotiate to ensure the process goes smoothly initially and in the future.
Simple things like being transparent with other family members who could be impacted is essential. When it comes to the best option for the structure of the arrangement and the finer details it is key to seek advice from a lawyer.