Housing affordability is a big issue for young Australians. The amount of the deposit a potential purchaser has available is relevant to how much they can borrow from any financial institution. It is hard to save a large deposit especially when paying rent at the same time. A recent election promise proposed as a solution that the federal government could become an equity partner in a purchase to reduce the requirement for a large deposit.
WHAT IS EQUITY:
Equity in a property is the difference between the value of the property and what debt is owed on the property.
Obtaining funds by giving a share in equity of the property is different than obtaining a loan to purchase property when the lender has a right to be repaid under the terms of the loan agreement but has no ownership rights.
WHAT IS AN EQUITY SHARE?
An Equity share gives different parties a precise legal entitlement to a share in the ownership of property at the time of purchase, with the result that there is more than one owner of the property. If the ownership is joint tenancy all parties technically own the whole property equally but if the property is held as a tenancy in common then the owners have a specific share in the property which can be equal or unequal.
For instance, if one person is a tenant in common owner in ¾ share and the other person is a tenant in common owner in ¼ share, then on sale the person who has a ¾ share is paid ¾ net selling price after debts such as the mortgage have been discharged. The other owner is entitled to the remaining equity share of ¼.
All parties have to agree to matters affecting the property including when to sell the property and the sale price. Strictly speaking the parties share proportionally the legal obligation for payment of outgoings although they may reach an agreement between themselves as to who should fund regular outgoings or who should cover routine repair costs.
WHAT ARE THE ALTERNATIVES TO AN EQUITY SHARE?
The most obvious alternative is to obtain a loan from a financial institution or some other source. But banks and other financial institutions look at a variety of factors when considering loan applications including what is the percentage value of the deposit that the potential purchaser has available comparative to the value of the property they want to purchase. That is do they have a 10% or 20% deposit plus enough money to meet any other acquisition costs?
Loans will be secured by a first mortgage on the property purchased and home owners [mortgagors] cannot register any second mortgage without the consent of the lender who is registered on the title to the property as the existing mortgagee.
WHAT ABOUT FUNDING FROM THE BANK OF MUM & DAD?
A common solution for young Australians wanting to get into the property market has been for parents to assist by advancing funds towards the deposit/purchase price.
If mum and dad are asked to give money to their adult child, rarely is it proposed they hold an equity interest. Adult Children may not want to have their parents intervening in property decisions as equity partners. But in any event holding an equity interest in their child’s property has potential to create a disadvantage for the parents. It may have adverse tax consequences and involves risk in respect of the liability to fund the bank loan the child might take out when buying a property.
A mortgage taken out over a property is ‘secured’ over the whole property even if it is taken out by only one purchaser to fund their share despite the other equity partners having sufficient cash to fund the remaining purchase price. This means that all parties necessarily would be required to become ‘mortgagors’ liable for the whole loan in the event of default even if the lending application is by one party only as ‘borrower’.
IS A LOAN OR A GIFT INTENDED?
Often parents advance money to increase the deposit their child has before applying for lender finance. But the risk is that there is no proper mutual understanding of the nature of the money handed over or if or when repayment might be required.
Mum and dad would rarely be able to have a loan secured on title to the property because lenders generally will not consent to the registration of a second mortgage for a first home purchaser when there is not enough equity in the property sufficient to discharge all liabilities in the event of a sale.
Typically, in these situations an informal arrangement is undertaken with mum and dad transferring funds to the account nominated by their adult child without any detailed or mutual understanding of the arrangement. Some lenders, on observing that a lump sum has been recently deposited into the adult child’s bank account, ask for a letter from the giver that any moneys provided are a gift and not intended as a loan prior to issuing final loan approval.
It is important however for parents to consider carefully what are their intentions when advancing money:
- Is the money intended to be a loan or a gift?
- Who is intended to benefit from the money? If the recipient is married is the loan or gift intended to benefit both spouse parties or only one of them?
- How might that money be treated if the recipient separates from his or her spouse partner? [Under current law a reference to spouse can include a de facto spouse and same sex spouse.]
- Is there any anticipated time frame for repayment of a loan?
Few people take the trouble to properly document loans between family members. Unfortunately, years down the track if there is a dispute about money the issue around ‘who’ agreed to ‘what’ can become quite messy and bitter.
In the event of a future relationship breakdown an important question would be whether the financial assistance given by the parent/s of either spouse was a loan or a gift. When the recipient’s relationship breaks down, he/ she might argue that the money received from his/ her parents was a loan to be repaid jointly by the separated parties prior to adjustment of the remaining marital assets. The ex-partner might argue it was a gift.
ARE INTENTIONS PROPERLY COMMUNICATED?
It would not make things clear if mum and dad are asked by their adult child to help with the deposit so he and his partner can get enough together to qualify for a loan to purchase a house and the parents agree using words such as “We will give you some money to tide you over, pay us back when you can” but the adult child then tells their partner; “Good news Mum and Dad are giving us the money to make up our deposit so we can make an offer on the house we love”. Mum and dad then transfer some money to the joint account of their adult child and partner but make no other comment or record.
The partner perhaps is entitled to assume the money is a gift, while the parents intended a loan. When no further conversation is held with all parties and nothing is documented, the nature of the transaction gets less and less easy to determine especially if the parents never make any request for repayment until the adult child and his/her partner separate.
HOW DOES A COURT DETERMINE LOAN v GIFT?
People’s memories often differ over time, and long after money has been handed over it might be difficult to determine if the money was intended as a gift to one or both parties or a loan requiring repayment.
A formal loan agreement made contemporaneously at the time of advancing the funds would be the best evidence to prove a loan existed but if there is no such formal document the court would consider what other available evidence exists relevant to the advancement of the funds before deciding if those funds were advanced as a loan or a gift. Available evidence might include:
- Whether any bank statements or records exist to show if any repayments were made or commenced?
- Whether there is any informal document proving intention? For example, did the parents record the transaction in their bank account as something like “Loan to John/ Jane”? Or perhaps one of the parties kept a spreadsheet of monies received entitled “Loan from mum and dad”
- In addition, each of the parties can provide evidence of their recollection of conversations held at the relevant time with the givers and recipients.
IF THE MONEY WAS A LOAN?
This usually has the result for the parents that they are entitled to have their loan repaid in full.
IF THE MONEY WAS A GIFT TO WHOM WAS IT GIVEN?
If it is established that money received from parents was a gift not a loan, typically the next source of dispute is whether the money was gifted to both parties, not just the parents’ child.
It can be alleged that the money was given to both the adult child and their partner at the time in recognition of the relationship that existed between the daughter/son-in-law with the parents-in-law; or because the parents-in-law wanted to benefit both their child and his /her spouse to provide a secure home for the grandchildren or just that nothing was said or done to indicate the money was anything other than a joint gift such as a wedding present. Or maybe the parents did make some statement such as “We want to help you both, that is what families do for each other”.
If it is decided that money was a gift to only one party or to both parties this is relevant to contribution in family law proceedings and in any event the parents do not get their money back.
CONCLUSION
Whether money given to any adult child or for that matter any relative or friend should be regarded as either a loan or a gift not only affects the right to recover money by the giver but also may be relevant to adjusting financial interests of a separated couple in the event of a relationship breakdown. If parents want to help their adult child to enter the property market by advancing funds, then each party should think carefully about whether the money is to be a gift or a loan, and the pros and cons of those options and if relevant the proper documenting of any loan if applicable.
If you or someone you know wants more information or needs help or advice on these issues, please contact us on 02 9699 9877 or email [email protected].