With soaring prices for residential property in New Zealand, the bank of “Mum and Dad” has become an increasingly popular option for first home buyers hoping to enter the property market. While it offers many advantages for both the borrower and the lender, it also places both parties in a risky position if expectations are not disclosed and/or do not align.
Gift or loan?
If you wish to loan your children money to assist them with their first home purchase, you ought to consider the nature of this lending, and whether you expect to have an interest in the property being purchased. What happens if the property is sold sooner than you expected? Similarly, if you intend to ask your parents for money for your first home purchase, do you expect to pay them back one day?
The intention of the lending is a key indicator of how it will be characterised in the eyes of the law. As such, parents and children alike need to transparently communicate their expectations and record these in writing to avoid any uncertainty.
Contribution from Mum and Dad
Some common examples:
- Gift – parents may choose to gift their children money to put towards either the purchase price or the deposit. Banks will often favour this arrangement as it does not compete with their security, as the borrower is not required to repay the gift.
- Loan – parents may loan money (with or without interest) to their children. An arrangement of this nature is generally recorded in a Deed of Acknowledgement of Debt or a Loan Agreement. In this case, the parent’s interest does not extend to the property itself (unless a right to mortgage is included) but rather, an expectation that they will be repaid at some point. This arrangement would need to be disclosed to the Bank if bank finance is also being obtained.
- Investment – if money is advanced on the basis that the parents will own a corresponding percentage of the property, the lending may be characterised as an investment. It is important to be aware that any profits earned on a sale may be subject to capital gains tax.
- Guarantor – parents may wish to use the equity in their existing home to guarantee the Bank’s lending to their children. Parents need to be aware of the nature and extent of the guarantee they are providing.
Tax implications are another important consideration for parents, particularly if there is uncertainty around how long the property will be owned. With recent changes to bright-line tax rules earlier this year, both parties should seek sound tax advice from their financial professional and consider what entities may be involved in the transaction.
Clarity of the expectations and intentions of the parties is crucial to ensure that misunderstandings do not arise in the future as to the nature of the lending and what was intended. A record of such between the parties and effecting legal documents that speak to the nature of the arrangement, mitigates the risk of an acrimonious dispute arising in the future – just make sure you talk to your lawyer beforehand!
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