Parents who want to help their children buy their first home should think twice about how they provide financial support.
One of my daughter’s friends is in the market for his first home, but he doesn’t plan to get a mortgage from a bank. Instead, he hopes to have his recently retired parents lend him the money.
Here’s his thinking: Although he’s already been preapproved for a five-year fixed mortgage, he hopes to get a much better deal from his folks. In fact, he’s pretty much convinced them that they’ll actually see a better rate of return than they do now from the stack of shorter-term GICs they’re using to fund some of their retirement expenses.
Good deal? Well, for him, sure — and maybe for his parents as well, providing they don’t spread themselves too thin.
Family Loans Can Be Risky
An intra-family mortgage can certainly help first-time home buyers, particularly if they have other competing expenses such as car payments or student loans. But lending money to your adult kids can also be a risky proposition if you’re not careful. Even a small loan can disrupt or sometimes destroy family relationships.
Many advisors discourage intra-family lending, largely because of the emotional issues created when adult children don’t stick to the plan, are late with their payments, default altogether or simply sow discord among other family members who aren’t directly involved.
How do you avoid family problems when help is given to one child and not others? The first thing is to avoid surprises. Before making any final decisions, be upfront with your other kids so they don’t feel they’re somehow being slighted.
Where Things Can Go Wrong
Although your first inclination will likely be to help out, look at the downside as well. Is your son or daughter’s income secure? What happens if they can’t — or won’t — repay the loan? What if they split with their partner? What if you die?
While it may not have been any of your business until now, make sure you understand the underpinnings of your children’s living arrangements and the impact they might have on any help you’re offering.
If they’re part of a couple and the relationship ends, for instance, the two parties would split any equity in the home. Keep in mind, however, that common law partners don’t have the same financial rights as legally married spouses should they break up.
Draw Up A Promissory Note
The simplest family loans are really nothing more than IOUs and are usually unsecured without any collateral. For smaller amounts, you don’t necessarily need a lawyer, but when the amount borrowed is large enough — you’ll have to decide what that means in your family — you’d be wise to set up a structured loan arrangement.
The loan itself should be documented with a promissory note that spells out the amount borrowed, the interest rate being charged, the specific terms of repayment, including the timing and amount of each payment due, as well as the expected payoff date.
In this particular case, the proposal started out as a “could you help with my down payment?” deal, without any contingencies if their son was late with his payments, for instance, or split with his partner. But those particular issues were eventually sorted out.
The couple wasn’t, however, completely upfront with their other kids, one of whom now feels a bit confused and somewhat slighted. Nor, at the time, did they realize that their son’s soon-to-be in-laws had also agreed to a similar arrangement.
You can probably do better.
This post is also available in: French