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Recent estimates claim that the ‘Bank of Mum and Dad’ is Australia’s ninth largest lender. Given the state of house prices, this comes as no surprise. Most parents want to help their kids, especially with something as important as buying a home. But it is important that things be done correctly. There is such a thing as ‘the wrong way to help’ when it comes to one generation trying to help another.

This was brought home to us recently when we discussed a situation that is really the ‘full catastrophe’ in terms of getting things wrong. About fifteen years ago, two parents and their two young adult daughters entered into an arrangement. The two daughters would each claim a ‘first home buyer’s grant’ to buy a house. The rules for the grant meant that the property could only be held in the daughters’ names. Nevertheless, Mum and Dad sold their own home and used the proceeds to pay for most of the house, with a relatively small loan being taken out to cover the rest of the purchase.

The initial plan – backed up by nothing more than an agreement over dinner – was that the house would be lived in by all four people for five years and then sold. Each would then take a tax-free amount out of the sale proceeds, commensurate with the amount that they had put in and their contribution to the loan maintenance. The plan for the loan repayments was that Mum and Dad would take care of them, but the two daughters would pay board to their parents.

So far, perhaps, so good. But young adults tend to see five years as a long time. In this case, both of the daughters wanted to move out of the suburbs before the five years were up. They did so, but this ‘mucked up the sums’ a little bit in terms of who was contributing what towards the loan.

But this was not the worst bit. After five years, with just the two of them living in the house, Mum and Dad decided that they really liked living there. They no longer wanted to sell the property. Instead, they kept on living in it, paying the minimum loan repayments each month.

Fast forward another ten years and the situation is not great. Mum and Dad are still planning to pay out the loan and live in the house until their plans change at some unknown future time. The loan repayment plan has now changed to Dad using his super – which he can access in two more years – to pay off the loan.

But the problems are myriad. They include:

• Both daughters now want to buy their own homes, but neither can access a grant as a first home buyer because they have already done so.
• The two daughters legally own the property. However, the loan, secured by a mortgage, is also in their name. This is compromising their ability to get a new loan, especially as the ‘tenants’ in their property (their Mum and Dad) are not paying them any rent. The daughters’ incomes needs to cover two potential loans – any new loan for a new property, and the existing loan. This can’t happen, meaning that the daughters cannot buy another house while the arrangement is in place.
• Mum and Dad have put all of their money, including making loan repayments, into a property that is legally owned by someone else. This places Mum and Dad at some risk, especially now that one of the daughters’ is married. Were that marriage to break down, for example, then her ownership of her parents’ home would count as an asset in any settlement.
• Because this is a loving family, no one wants to assert their legal rights over any other person.

The simplest thing to do would be for the family to transfer ownership of the asset from the daughters to Mum and Dad. That will, however, incur a stamp duty which can be around 5% of the value of the property. As the daughters have not lived in the house for several years, there may even be a capital gains tax issue. Stamp duty is levied on the ‘purchaser,’ which in this case would be Mum and Dad.

So, the simplest solution is also an expensive one. The problem in this case is that, 15 years ago, Mum and Dad did not actually act like a bank. Essentially, they put all their money into an asset in their daughters’ names. This was done mostly to gain a small advantage in the form of a first home buyers’ grant. The idea may have right: the young adults would own the home, live there for five years, get themselves a good credit rating, before selling and paying back what was essentially a loan to them from their parents.

The problem was, no one realised at the time that Mum and Dad were being a banker and actually making a loan. Mum and Dad are now left with a lot of their wealth (which will include some of their super when they retire) essentially being held as an undocumented, and unsecured, loan to their daughters. What’s more, because the arrangement places all the documents in the daughters’ names, the daughters are quite compromised as well.

All of this could have been avoided had the family (and especially Mum and Dad) sought the assistance of an adviser like us before they proceeded 15 years ago. The really sad part is that there are good, safe ways for older generations to help out their kids or grandkids financially. But you need to get things right before you act.

So, if your family is in line for some inter-generational banking, please don’t do anything without talking to us first. We can help you avoid very costly errors.