Protecting the Bank of Mum & Dad (and its Customers)

Protecting the Bank of Mum & Dad (and its Customers)

Nearly 50% of young Kiwis aged between 18 and 39 years old view assistance from family as the only feasible path to home ownership.[1] Whether it is a contribution toward a deposit, help with bridging a shortfall, or funding renovations on a first home, the “Bank of Mum & Dad” is one of the most active lenders in the country. Unlike a commercial bank, these arrangements are often relying on family goodwill, with little thought given to the legal consequences if circumstances or relationships change. A small amount of planning in the beginning can protect the parents as well as the child receiving the financial support.

Formalising the Agreement

Whether the intention is that the financial assistance will be a gift or a loan to be repaid, documenting the arrangement at the outset is crucial.

A written loan agreement should record the amount advanced, whether interest is payable, the terms of repayment (including whether repayment is on demand or by instalments), and what happens in the event of default. Where the sum is significant, parents might also want to register a mortgage over the child’s property to secure repayment. Without written terms, there is a real risk that the amount advanced will later be argued to be a gift, whether by the child’s spouse on a separation, a creditor, or a government agency assessing entitlements.

If it is intended that the funds are a gift, this should also be documented (but see below for matters to be considered before a gift is made).

Even where the family relationship makes formality feel unnecessary, a signed document protects everyone. It gives the child clarity about their obligations, gives the parents evidence of the loan if they ever need to enforce it, and removes ambiguity that can become the source of painful disputes down the track.

Contracting Out Agreements – Protecting What Parents Have Given

If the child is in a relationship, a step a child can take when receiving a gift or loan from their parents is to enter into a contracting out agreement under the Property (Relationships) Act 1976, to provide that the advanced amount remains “separate property” under the Act. Without such an agreement, property acquired or improved during a relationship using gifted funds could be classified as “relationship property” under the Act and subject to equal division if the child’s relationship ends.

Having a contracting out agreement in place protects not only the child’s position but also the parents’ investment (or gift), particularly where there is an outstanding loan that might otherwise be compromised by a relationship property claim.

Such agreements should be entered into as early as possible, preferably before the gift or loan is made.

Residential Care Subsidy

Parents who are considering financially helping their children should also be aware of the potential for a loan or gift affecting the parents’ eligibility for the residential care subsidy in their later years.

When the Ministry of Social Development carries out a financial means assessment of a person’s assets and income for subsidy purposes, it will look back at any gifts made and if a parent has given away more than the allowable amount in any twelve-month period, the excess will be treated as a “deprived asset” and counted as though the parent still holds the gifted funds, potentially disqualifying them from  being eligible for the subsidy.  Likewise, if an interest free loan is made to a child, the lack of interest could be treated as “deprived income” and an amount included back into the income available to the parent to support their care needs, and the loan itself will count as an asset in the financial means assessment.

One way to mitigate the risk of exceeding the permitted gifting thresholds is through a structured gifting programme, under which parents gift modest amounts each year within the allowable thresholds rather than transferring a lump sum all at once. Advice should be obtained on this however, to ensure all factors relating to the specific circumstances of the parents are considered at the time of the gift or loan.

Equalising the Benefit Among Children

Parents will likely also be concerned about ensuring fairness between their children.

One option to attempt equality is to include a hotchpot clause in your will, which provides that any lifetime gift to a beneficiary is to be brought into account when the estate is distributed, so that the child who received a gift has that amount notionally added back to the estate before shares of each child are calculated. The effectiveness of this option however depends on the value of the parent’s estate at the time of their death (e.g. there might not be sufficient funds in the estate to achieve overall equality between the children).

This highlights that particular care and planning needs to occur, to ensure the parents’ future financial needs are not compromised and also to reduce the family friction and inequality that can arise between siblings where one child has received financial support but another child has not (or has but to a lesser extent). 

Guarantees

Another way parents help their children into their first home is by providing a bank with a guarantee for their child’s lending. Parents should be very cautious about providing such a guarantee, particularly if the guarantee is unlimited, as the guarantors are liable for the full sum owed plus any interest and costs of the bank’s enforcement if the child defaults on their repayments.  This could negatively impact the parents financial planning, financial security and standard of living.

Conclusion

Supporting your children financially might be a simple choice, but care, planning and advice is needed to put the correct arrangements in place and prevent significant difficulties down the line.

Special thanks to Partner Lisa Small and Solicitor Sophie Hall for preparing this article. 

Disclaimer: The content of this article is general in nature and not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.