Now more than ever Mums and Dads are helping their children financially. In the lead up to Christmas we completed six “Bank of Mum and Dad Loans”.
Background
In days past, Mum and Dad provided financial accommodation as a Gift (no consideration). However, with the increased rates of divorce, complex family arrangements (blended families) and generally the greater risks in day to day living, such Gifts do not adequately protect the financial accommodation provided. Now financial accommodation from parents to children is generally provided as a Loan and ideally with security to protect the funds advanced.
The risk of getting the financial accommodation wrong can be substantial:
- Loss of the financial accommodation to a child’s spouse in a breakdown of a relationship.
- Loss of the financial accommodation in the event either the children or parents are sued.
- Uneven distribution of Mum or Dad’s Estate where Loans are not detailed in the Will.
- Unpaid Loans used as weapons in complex estate planning disputes.
If you don’t document the financial accommodation as a Loan with formal documents, it will most likely be treated as a Gift. This can lead to the loss of the financial accommodation provided.
The purpose of this article is to highlight what you should cover off when documenting a Bank of Mum and Dad Loan.
The Bank of Mum and Dad: 10 key principles
1. Borrower Identification: Align Liability with Asset Use
- Loans should, wherever possible, be advanced to both the child and their spouse or partner.
- Joint borrower structures better reflect the economic reality where funds are applied to shared assets, most commonly the family home.
- Loans to a single child are materially more vulnerable to being characterised as a parental contribution rather than a shared liability.
- Further considerations:
- Review property ownership structures to ensure consistency with borrower arrangements.
- Consider guarantees or indemnities where financial capacity is uneven.
2. Loan vs Gift: Make Intention Clear and Defensible
- Courts assess substance, not labels; a genuine loan requires an objectively demonstrable expectation of repayment. An arrangement drawn as a Loan where there is no repayment of capital or interest runs the risk of being seen as a Gift.
- Consistency across documentation, conduct, accounting and estate planning is critical.
- Informality or indulgence over time can support a finding that funds were intended as a Gift.
- Further considerations:
- Periodic loan statements or written acknowledgements reinforce intention.
- Informality is rarely curable later, particularly after a relationship breakdown.
3. Documentation as Strategic Infrastructure
- A properly drafted loan agreement should address principal, interest, repayment mechanics, default and enforcement rights.
- Documentation should evolve as circumstances change, not remain static.
- Courts readily discount agreements that are ignored in practice.
- Further considerations:
- Template agreements are often insufficient for family arrangements.
- Behaviour must consistently support the written terms.
4. Security is needed
- Taking security; a registered mortgage or caveat materially strengthens enforceability.
- As a general rule where Mum and Dad are providing full funds we recommend a mortgage. A caveat (which is a notice on title and not a form of security) is generally used where a Bank is providing most of the funds and has taken a mortgage.
- Secured loans are far more likely to be recognised as genuine liabilities in family law proceedings.
- Unsecured parental advances are routinely given reduced weight in the event of real conflict where the Loan needs to be relied on.
- Further considerations:
- Priority position should be considered where refinancing is likely.
- Security also improves protection against insolvency and third-party claims.
5. Interest Treatment and Tax Alignment
- Interest may be commercial or nominal, payable or capitalised, or a combination of both.
- Any interest received will generally be assessable income to the lender – in this case Mum and Dad
- Inconsistency between legal terms, tax reporting and conduct undermines credibility.
- Further considerations:
- Nil-interest loans require careful justification and consistent treatment.
- Tax reporting is frequently used as proxy evidence of intention.
6. Source of Funds and Asset Protection Strategy
- How parents lend personally, through a trust or other structure can significantly affect a person’s Estate Planning and Asset Protection strategies
- Loans provided from Mum and Dad personally are assets of their Estate:
- Can be taken into account in Estate Claims.
- Consideration should be given to whether the Loans are forgiven, taken into account in the division of the residue or transferred to the beneficiary as part of their Estate. This is especially so whether the beneficiary has the benefit of a testamentary trust and where the benefits of the Loan want to be preserved post death of the Lender.
- Loans provided by Family Trusts to children sit outside the Will. Consideration needs to be given to who will control the Family Trust and will the Loan be adjusted against other Estate assets.
- Further considerations:
- Trust-held loans raise control and succession issues on death or incapacity.
- The lending vehicle should align with broader asset protection objectives.
7. Loan Term, Repayment Mechanics and Trigger Events
- Open-ended loans invite uncertainty and dispute.
- Loan terms should include a defined term or maturity date.
- Clear trigger events strengthen enforceability and preserve control.
- Further considerations:
- Common triggers include sale, relationship breakdown, death or insolvency.
- Enforcement rights matter even if never exercised.
8. Integration with Estate and Succession Planning
- Parental loans should never sit outside wills and succession strategies. When undertaking Mum and Dad Loans, their Wills and general Estate Planning should be considered.
- Loans may be forgiven, equalised against the estate or transferred as enforceable assets.
- Will-drafting should reflect relationship stability and family dynamics.
- Further considerations:
- Consider strategies involving grandchildren where relationship risk exists with children.
- Unequal advances should be addressed expressly to reduce dispute risk.
9. Managing Relationship Risk Proactively
- In appropriate cases, making a Binding Financial Agreement (BFA) a precondition to Mum and Dad advancing the Loan materially reduces uncertainty. A Mum and Dad Loan is only part of the equation and should be used with other strategies
- BFAs can clarify how the loan is treated if a relationship ends.
- Early structuring delivers far stronger outcomes than retrospective protection.
- Further considerations:
- Guarantees or indemnities may further reinforce the position.
- Insurance linked to loan exposure can mitigate unexpected risk.
10. Advice Boundaries, Compliance and Professional Risk
- Advisers cannot ordinarily act for both parents and children.
- Clear advice boundaries protect both families and advisers.
- LP/PI/LPLC and compliance considerations require disciplined file management.
- Further considerations:
- Parental loans are often the trigger for broader strategic advice.
- Early coordination between legal, tax and financial advisers maximises outcomes.
Key Takeaways
- Formal Mum and Dad Loans with security offer the best protection to financial advances provided by Mum and Dad to children.
- Mum and Dad Loans should be considered as part of a wider wealth transition strategy including Estate Planning
- Appropriate Legal, Accounting and Financial advice should be sought prior to the financial accommodation being provided.
