Loaning money to your kids? What can go wrong?

Melissa Patterson, director of Argent Law, discusses why loan agreements between related parties are an important way to mitigate risks….even those you don’t even know are there yet!

It is very common for family members to lend each other money. For example, one very common is the situation is where parents lend money to their children. This is getting more and more common place, especially in a climate where housing prices are so expensive and the cost of living (and spending) just keeps getting higher for young people. As lawyers, clients often come to us with an all too familiar complaint,that goes something a little like one of the following – “I lent my son and his wife money but now they are breaking up and I want it back, but I have no proof!” Or maybe it goes something like “I lent my son and his partner money with no interest rate and now that they’ve have broken up, I want to back charge interest on the money I lent them!” We’ve also heard more than once “I lent my child some money and now they are going bankrupt!” There is one very simple way to circumvent or minimise these issues – And that is to ensure that a loan agreement is prepared between the parties!

Loan Agreement – No Ambiguity

Firstly, a loan agreement takes away any ambiguity about the terms of the advance. It can specify the amount lent, events where the loan can be called in such as a breakdown of a relationship and importantly it ensures that should you pass away before the loan is repaid that the amount owing will be deducted from that child’s inheritance. This ensures consistency and equality between your children and may prevent fights or litigation after your death.

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Loan Agreement – Document As A Proof

Secondly, it is just good practice! You lend money, you document it. This is especially important if your child gets himself/herself into financial difficulty – for example going bankrupt. A trustee in bankruptcy will not just rely on your word that the money was not simply a gift! To the contrary they may go to very long lengths to prove it was a gift so that they can retain it.

Loan Agreement – Gift or Loan?

Thirdly, if you are advancing money for a purchase of a property and the bank insist on recording the money as a gift – you may have trouble trying to recover this money. Official documents show it is a gift not a loan – if you then try and say that these official bank documents were incorrect you may put the mortgage at risk or even worse all be deemed to have obtained the loan fraudulently. If the bank being approached for a loan is insisting that the money lend must be classified as a gift, then perhaps a second-tier lender may be more appropriate. There are other mechanisms that can be utilised such as being a guarantor to the loan – using property as collateral or a different loan structure. This will be unique to each circumstance and one solution does not fit all!

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The Family Court

The Family Court is very particular about a ‘gift vs loan’ argument and although you may ultimately be successful it could be very expensive for you. You will most likely be joined to the family law proceedings as a third party – have to engage a lawyer- file affidavit material – respond to affidavit material and if you are really unlucky you will have to be a witness and give evidence and be cross examined. If for some reason you need the money paid back sooner (for reasons such as you or your spouse are unable to work and you need some or all the money returned), it’s always much easier when you can rely on a clear and fair loan agreement.

Avoid Future Trouble By Drafting An Agreement

Quite simply, there are very good reasons to get a loan agreement drawn up! The process does not need to be costly to have the document prepared and it is the best security for all parties. I have seen far too many times, negative implications of not doing this from the outset. If I find out that any of my clients have or are going to lend money to their children, I insist that they let me prepare a loan agreement and have had many clients contact me a few years down the track thanking me for pushing them on this point. Remember, you can turn your loan into a gift at any stage, but the reverse of this is very difficult, whereby you wish to turn your gift into a loan! Your initial intention may be that the money is a loan and then you may change your position and decide it is an outright gift. If that is the case, then the loan agreement will be torn up and written confirmation will be provided that the loan is now a gift and not repayable.

Contact Argent Law If You Have Lent Money To A Family Member

The moral of the story is no one has a crystal ball and we do not know what is around the corner. What we can do is control the way our money is provided to family members and make sure the circumstances are documented, with certainty for all involved.

If you have lent money to a family member, please contact our office on 03 9571 7444 to discuss the preparation of a loan agreement.

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