With the price of real estate on the rise and the time taken to raise a deposit even for hard working couples or individuals, more and more home purchasers are doing so with the assistance of a loan from their parents. These loans have some common features that people need to think about.
The first issue that the lenders and borrowers need to think about is whether the loan will be secured or unsecured. A secured loan is just a loan that is the subject of a mortgage. If the parents are the only lenders, then it makes sense for the loan to be the subject of a mortgage and the mortgage should almost certainly be registered against the title to the subject property. Indeed, even if the main lender is a bank, it is probably a good idea for the second loan to be the subject of a mortgage.
The steps that need to be taken to create a mortgage are the preparation of the mortgage document and signing by all parties. Note that in order to be enforceable, even if it is not going to be registered, stamp duty needs to be paid on the mortgage.
Whether that mortgage is registered will depend on what the new buyers intend to do with the property. When the mortgage is registered, its existence will become known to anyone who searches the title to the subject property. If the child borrowers intend to live in the property for quite a long time and gradually make renovations (or not), then it may not be necessary for the second mortgage to be registered. However, if the buyers propose to make major renovations as quickly as they can and then “flip” the property to achieve a quick capital gain, then the mum and dad lenders should probably insist on registration of their mortgage, so that they have priority against other new lenders who might be funding major works.
The next major issue to think about is to ensure that the loan is treated as a loan and doesn’t look like it might be a gift. The first most obvious way to ensure that a loan stays a as a loan is to have it documented by a loan agreement. This need not be an incredibly detailed document, but is probably worth having even a simple straightforward loan agreement professionally drafted. The next safeguard is to provide in the loan agreement for some repayments – even a small annual repayment means that the advance almost certainly can’t be treated as a gift.
The next pitfall to avoid is being caught by the Limitation Act. Generally, all debts in NSW can only be legally enforced within 6 years of the date on which they become payable. A loan that is expressed to be “repayable on demand” is due for payment immediately upon it being advanced and the 6 years clock starts to run straight away. So this is a term of phrase to avoid, even if the intention is that the borrowers will repay the loan when they are able to get around to it. It is much better for there to be a loan agreement that specifies a future date for repayment (say, 30 years) and to provide for some minimal annual payments than to run the risk of the loan converting to a gift because it has become unenforceable.
Another area to give some thought to is the situation where the parent lenders have advanced the whole of the purchase price for the subject property. Under trust law, where one party advances the whole of the funds for the acquisition of an asset in the name of another party, that will give rise to a constructive trust from the owner in favour of the party that advanced the funds. However, there are some classic scenarios where a constructive trust will not apply, because the court upholds what is known as a “presumption of advancement”. Such a presumption arose in advances between a husband and wife, or between parents and a child. There has been recent High Court authority that presumptions of advancement still exist in Australia, but the court also emphasized the importance of the intentions of the parties and how the property has been regarded by them since purchase. It is best to avoid this pitfall by again preparing a simple document that records that the funds were advanced to the purchasers of the property by way of loan, that the property is intended to be theirs and that no trust is to be taken to have come into existence by the parent-lenders providing the funds.
All of these safeguards and pitfalls can be fairly easily addressed by taking a small amount of time and not much effort to get legal advice about the loan from the bank of mum and dad. Given the sums involved and the potential traps, the fees are a small investment in achieving significant peace of mind.
Written by
Stephen Rugendyke
Special Counsel
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