Whew, the economy is TOUGH right now. And it is so interesting professionally to see how this flows through in the work we are asked to do. After 10+ years of practice, I can confidently say, a business and commercial lawyer’s work changes quite a bit depending on what’s going on in the world.
We are seeing a massive upswing in family loans taking place as parents try to help their adult children into the housing market. For some who made a ‘no strings’ loan a few years ago, the lack of formal planning has come back to bite them. They may be a bit uncomfortable seeing their borrower using that extra equity to buy themselves a boat (yes a boat, and yes this is based on a real example).
If you take away one tip from this article, it is sooo much easier to get formal documentation sorted at the start when everyone is working to a deadline like a property purchase, than to try to pick it up later.
It reminds me a bit of pre-nups. When you’re in the throes of wedding planning, it might seem like you’ll be together forever and anyway if everything was to fall apart, you trust that the other person will be reasonable and split everything amicably. But it’s an old saying that the person you divorce is a different person to the person you marry.
When everything is good, you can rely on people to behave in predictable ways. When the economy starts to bite, or someone separates from their partner, loses their job, or there is an unexpected death or disability, the responses are more unpredictable. We all know that life is messy and complicated.
Asking the tough questions
So what does this have to do with lawyers? I often describe myself as a professional pessimist. When family members are looking to lend money to one another, there are a whole set of questions I go through with them to check how we need to structure the loan.
As an outsider, while you may feel a bit awkward asking these questions or choosing the right time to bring up the conversation, I do it every week and don’t have to worry about causing offence or making people a bit uncomfortable. Usually the questions include things like:
- Who is the lender and borrower and are they the right people to choose for tax reasons?
- How much are you giving?
- What is it going to be used for?
- Do you have other children and do you need to make sure they get an equal benefit? What does this look like?
- Is it a gift or a loan?
- Is it surplus money or is getting it back a part of your financial plan?
- What do you want repayments look like?
- Is there interest payable?
- Are you happy that you are also lending this to their spouse or future spouse?
- What happens if you or they pass away?
- What happens if they sell their house? Do you want your money back?
Some of this also ties into what needs to go in your Will – and that can require family law advice too.
Once we’ve gone through this process of deciding what the loan looks like, we then document it. This makes sure that in 20 years’ time, everyone’s memory about what was agreed is going to match.
The power of sale
Sometimes in that process we also take out a caveat or a mortgage on a property. A caveat is an alert to the world that hey, someone owes me some money and when they sell this property, I’m probably going to want it back. It stops a sale going through and gives an opportunity to get your money back or reassess the loan – assuming there is equity to be had.
A mortgage is most easily distinguished from a caveat because it comes with a “power of sale”. Most of us understand this as we know that if we don’t pay our mortgages, the bank can come and sell our house to get what they are owed.
A private mortgage is essentially the same, placing the lender in the position of the bank and giving them a power of sale. I often tell people that just by virtue of these ‘incentives’ existing, it makes it more likely that your borrower will make sure you’re repaid because they understand what the potential consequences are if they don’t.
What about court?
If we all do our jobs right, the chances you end up at court are drastically reduced. If you do need to go to court, having a documented agreement is going to save you a day or two in court of putting on evidence and trying to convince them what the arrangement was. This could add up to tens of thousands of dollars saved. And of course, the fact that we asked the tough questions and documented it in the first place means there should be a fairly limited number of things you can disagree about later.
Alternative options
Family loans is something that often gets brought up as a potential alternative to going guarantor on a loan.
Sometimes we go through this process and decide that a family loan actually isn’t the right option and we can look at things like joint ownership on a property or setting up a trust.
There are so many financial, tax, and personal factors that come into play when we design a bespoke solution for you. Different things will work for self employed people and those who own farms. We also need to consider the timing and consequences on qualifying for Centrelink age pension.
As business lawyers, we are not only trained in legal considerations, we also get to see how different people structure things every day and understand the consequences of the options. Understanding your whole situation might mean we can give you some other creative ideas you hadn’t thought of.
Summary
In navigating the intricate landscape of family loans, it’s essential to acknowledge the ever-evolving dynamics of both relationships and finances. As we witness the ebb and flow of economic tides, the decision to extend a family loan can carry significant implications for all involved. It’s prudent to expect the unexpected by asking tough questions and having a plan.
Embrace the role of the “professional pessimist” in helping you avoid the pitfalls (and believe me we know about them as we spend a lot of time fixing them too!). Bespoke, tailored solutions for you to avoid the common mistakes and issues that stress you out and cost you money. That’s why we’re here!
Reach out today via a free curiosity call or:
> Phone: 0492 945 068
> Email: sarah@curiumlegal.com.au
