How advisors can protect clients borrowing from the ‘Bank of Mom and Dad’

Lawyer urges advisors to document their loans and set up marriage contracts to protect their capital

How advisors can protect clients borrowing from the ‘Bank of Mom and Dad’

About one-third of all new homebuyers are asking for their parents’ help, and advisors can help these families protect their money by taking a few simple steps, says one Toronto lawyer.

“We’re seeing roughly 33% of all new homebuyers going to the ‘Bank of Mom and Dad’,” Anna-Marie Musson, founder and managing lawyer of Musson Law, told Wealth Professional, noting that’s especially happening in the Greater Toronto Area, Vancouver, and Calgary, where house prices are rapidly increasing.

“There’s been a 13% a year rate increase in Toronto, and that number is only going to get higher. First-time homebuyers who are trying to get into the market have the income to support a fair mortgage, but they need a larger down-payment, so they’re turning to their parents for that help.”

Parents may want to help, but not know they need to protect their money. If one set of parents, for instance, loans the down-payment, but doesn’t document that it’s a loan, then, when the couple splits, it becomes part of the matrimonial property and is split in half, even though one side contributed all the money.

“Typically, one person gets a windfall, while the other loses the equity,” said Musson. “The parents lose out on a pretty significant amount of money and now the child is behind the eight-ball again because they want to try to get back into the real estate market, but now they’re trying to get financing and buy out someone who contributed nothing toward the family home.”

That’s a problem because Statistics Canada says 50% of that 33% of new homebuyers ends up breaking up. Musson estimates it’s actually 60% since Stats Canada only counts divorce rates and not cohabitation agreements that end. She’s seen a 10% increase in prenuptial agreements, or marriage contracts, which still leaves many couples unprotected.

Musson urges advisors to go over these points with their clients if they hear their families are contemplating this move.

“Make sure that the parents recognize the risks that could happen if they lend or gift the money since this can have a significant impact on someone’s net worth,” she said. “Most people don’t even think about it, and then they always come to me and say, ‘why didn’t someone tell me?’”

Parents who don’t have the extra liquid cash to loan their kids can take a second mortgage, or extended line of credit, on their house, to provide it. But then they need to draw up a loan agreement or promissory note to ensure it’s repaid.

“We need to protect the money from the parents, but we also need to protect the money between the couple so that it goes back to the child on a break-up, so the child can then repay the parent,” said Musson.

“The other thing couples need to be aware of, if they’re taking a loan from their parents, is they need to be certain that their bank is going to be okay with that because it’s going to affect the kids,” she added.  A lot of banks don’t like the idea that there can be this separate secured loan on a property that they have the main interest in.”

Then, ensure the loan is actually a loan. There must be a loan document specifying that it’s a loan and laying out the repayment schedule and terms and consequences if payments are missed. Otherwise, the courts will consider that it’s a gift and it will be split in half if the couple breaks up, regardless of who provided the money.

“That’s where we’re getting people jammed up,” said Musson. “So, it should be a two-fold process. You need a promissory note or loan agreement to make sure that the parent gets the money back, and then you need a marriage contract to protect the money and ensure it’s classified as a loan and not a gift.”

“Then, if the couple breaks up, the money goes back to the parents, and the couple splits the remaining amount if they’ve made money on the house,” she said. “That leads to a much fairer result and people aren’t shocked because you’d be surprised how many people are shocked when they come into my office, and I have to tell them that half of their parents’ money is gone. It’s horrible! We’re not going to get this money back without this type of agreement.”

It won’t work to have one member of a couple claim the money is a loan, not a gift, as they often do in her office, unless there’s paperwork to prove it. It also can’t be excluded from the matrimonial property without that document.

Musson urges couples to draw up a marriage contract for this, even if it’s just to protect the child’s gifts.

Advisors should also be aware that urging these steps can cause family tension. Children may resist a marriage contract if they feel parents are expecting the couple’s break-up or that their parents don’t trust the child’s significant other.

“It’s not about that. It’s about taking a step back and using one of the tools in your toolbox to complete your financial picture,” she said. “It’s no different than buying life insurance. But, you know, I will give credit to the millennials. We’re seeing that they’re having these conversations about their financial goals before they’re getting married.”

“A modest effort at the beginning of this transaction can make a world of difference, so everyone is on the same page, parents and kids know exactly what’s expected, and the couple knows what’s expected, too,” said Musson. “It’s a pretty simple solution to protect mom and dad and also protect the child.”