DAVID KOCH: Beware the risks of Bank of Mum & Dad

There’s the old saying that you can’t put a price on love. But the Bank of Mum and Dad provided $2.7 billion to their adult children to buy property over the past year.

The Productivity Commission estimates mum and dad as a collective would be between the fifth and ninth biggest home loan lender in Australia.

We all love our kids and, like we were at their age, they are impatient when it comes to getting ahead with things like buying a property.

The big difference is that our parents’ generation would largely encourage us to work harder and make sacrifices while today’s parents are more likely to stump up the cash themselves and help out financially.

We all want to help our kids. That’s the core of being a parent. But the question is what that help looks like.

As baby boomers we’re more than likely to be guilt-tripped into helping financially. We caused the high price of property, we’ve made it hard to save for a deposit, we have all the cash, we don’t have to pay high interest rates, we live a better lifestyle.

All the same arguments we used at their age on our own parents. The inter-generational wars have literally lasted for generations. Your adult children will be having the same argument with their children.

A University of Newcastle study found parents offering their children help on the property ladder are at increased risk of financial elder abuse. Borrowing from the Bank of Mum and Dad encourages ageist attitudes which leads to kids financially abusing their parents.

I’ve seen too many close friends lose big chunks of their savings, and have to scale back their retirement lifestyle when they act as a family bank and things go wrong. And it’s not just the finances that can suffer, either. Relationships can quickly sour and families can be torn apart by money issues.

But there is a solution. Parents can help financially, kids can get the money and there is a safety net which protects everyone.

If you’re playing the role of a bank, don’t be afraid to act like one. Treat the loan as a business transaction and draw up a formal agreement between each party outlining the terms of the deal, including a set repayment schedule.

Using a lawyer to draft this helps to avoid potential pitfalls, signals that you’re serious and can also help to ensure the money stays in the family if your child’s relationship ends.

At the end of the day the most important thing is to communicate. If a payment is late, deal with it straight away and don’t let things fester or become awkward.

Some parents may be in a position to gift money to their children. While gifts are great in that they’re generally tax-free, if tax has already been paid on the money, there are pitfalls to be aware of.

For example, if your child is married or in a de facto relationship and it ends, gifts will usually be considered part of the family assets and divided up in court.

On the other hand, formal loans are legal liabilities for your child and their partner, which will ensure that your gift doesn’t leave the family unintentionally.

Becoming a guarantor for a loan sounds like a simple proposition to help out. Fill out a couple of forms, sign on the dotted line and think happy thoughts about how you’re helping your child get a loan and realise their dreams.

But if things go wrong and your child defaults, that fuzzy feeling can quickly translate into cold hard cash, so it’s important to stop and think hard about what would happen if things go wrong.

In many cases it’s possible (and prudent) to limit your liability to a fixed amount that you can realistically afford to repay. An unlimited guarantee means you can have unlimited risk. If your kid defaults on a loan it’s way easier for a financier to go after you and your wealth than your child.

If you’ve raised a family of budding entrepreneurs, it’s highly likely that at some stage your children will ask you to invest in their new business. Now, I’ve been involved in small business for decades and think entrepreneurship is something to strongly encourage — sensibly.

Think of your role as that of a regular investor.

Ask to see a business plan, and feel free to make suggestions or call out areas for improvement, and be clear about what this money entitles you to when the business takes off.

And don’t front up the entire amount either.

If they haven’t got any money, tell them to save and come back when they do. Or give them a small amount of what they’re asking for with the promise you’ll add to it if the business passes specific milestones.