Many moms and dads lend their children money for their first homes. But parents may actually cause harm to their own financial picture if they fail to plan the loan carefully. Kim Parlee talks to Nicole Ewing, Director, Tax and Estate Planning, TD Wealth, about how you can protect yourself and avoid family rifts.
- Nicole, it's great to have you with us. I'm going to jump right in here, because we have, as I said, some big questions to answer today. And one of them really involves parents trying to help their kids get into the housing market as prices go up and it gets a little trickier. But of course, loaning money, not as straightforward as people should think. So let's start with the question, and we'll bring it up, here it is. How can I protect myself when I loan my kid money for a house? Nicole.
- Well, and I love that the question is being asked, because it is so critically important to make sure that you are protecting yourself. And the best way of doing that, of ensuring that there's both an understanding of the terms and the agreement between everyone is to have a formal, documented, written down, lawyer reviewed and created agreement between the parties. And this is going to help protect both the parents and the children going forward.
So we're not talking here about verbal agreements or kitchen table conversations. We're talking about a formal loan agreement between the parents and the children.
- And why is that so important? And maybe talk a bit about the elements that are inside of it that make this so important?
- Well, this gives you the opportunity to think through all of the potential issues that might arise. So what is the loan amount? How much are we going to be loaning? What's the repayment schedule? How often and in what amount are we expecting repayment? What are the interest terms? And keep in mind that this interest is income to the parents, so it needs to be included in their tax returns and paid tax on as well.
So being clear about that, and really understanding the enforceability. What happens in the event of default? Are we going to secure against the property? Who are we making the loan to? Are we making the loan to our child? Are we making the loan to the child and the spouse? And there are better and worse ways of doing that. But being really clear and making sure that you understand what the implications are and the consequences are for all of the parties involved.
- Clarity is so important to your point, especially when spouses get involved, families get bigger, creditors get involved, and that's a whole other piece to talk about. But maybe what are some of the other benefits of drawing up a loan?
- Well, ultimately we're looking at certainty. And we're making sure that everybody understands what's going to happen, and that includes in the event of death of the parents. So they have the opportunity to include in their wills, for example, a loan forgiveness clause. They could refer to the will-- to the loan and make sure that everybody knows that it exists, because if we step back for a second and think, this loan can be outstanding, firstly, does anybody know it exists? Do the other siblings know about it? Do they have questions about it? How much has been repaid? Is it recorded somewhere?
The executor of the estate ultimately has a responsibility to call in all of the assets of the estate, to collect them. And so if the parents don't want the executor going after their children for these funds, if instead they want it to be included as part of the children's inheritance, they have the opportunity to say so. To explicitly say what the issues or how they want that treatment to happen.
It can also provide protection to other individuals. So just making sure that everybody understands what the obligations are, and that there's not hurt feelings by some of the family members who might not really know the full story.
- Yeah. Transparency and clarity is everything, and nothing does that better than a signed agreement between people to understand what's going on. What about the idea that-- I mentioned at the top that the housing market is harder to get into than it's ever been, just simply because house prices have gone up so much. So is this something you think parents should actually be doing?
- Oh, I love that question because we know that parents want to be helping their children, and there's a variety of ways that they can do that. But when we're talking about the values that are potentially at play here, this could impact the parents' ability to retire. They may or may not have the funds available to actually do this and be protecting their own financial security, and we want to put your mask on first before you're helping others. Make sure you really understand what the implications are.
So if you are loaning this money and receiving very low interest on it, there's an opportunity cost to that. You're potentially forgoing the opportunity to be earning income that you might need for your own retirement. And then if there's multiple children, if we are making loans to one child now, are we committing ourselves to making similar loans to other children in the future-- second and third children, with values increasingly going up? The question really can impact whether or not the parents are going to be able to secure their own financial futures first.
- And one thing I want to go back on, I know that earlier you and I were speaking, when you talk about the value of getting this loan in place, was that it should be specific to your situation. It shouldn't be something that you just download to try and make this all work.
- Oh, 100%. You might find on Google, there might be some online documents that are there. This is not a DIY situation. This is not the time to take it into your own hands, because firstly, we want to ensure that it's actually enforceable. What is the point of entering into this if it's not actually going to be an enforceable document? And there are certain key terms that need to be there.
So, for example, there are laws about credit, or the amount of time that passes before you can enforce one of these loans. And so if a parent doesn't enforce it, doesn't collect the funds, doesn't require the interest to be paid, after a couple of years, they may no longer be in a position where they can actually enforce it. And what happens if there's a breakdown in the marriage, if there's another creditor who's coming after the child. So yes, this is one of those times where we really do want to invest in professional advice and making sure that the document says what we want it to say, what we intend it to say, and that it's actually enforceable at the end of the day.
- And I think that professional advice, obviously how you draw it up, but also your own personal financial situation, make sure that it makes sense for you. Talk to an advisor, talk to a planner.
- Absolutely. And have them talk to each other. So having your financial planner, your investment advisor, your lawyer, all speaking together as well to make sure that the plan that they're coming up with for you really does meet your unique circumstances, that everyone's on the same page, that we're not inadvertently undermining each other or making assumptions, but that we have a lot of clarity about the situation, and that we're all partnering together to deliver a solution that works best for you and your particular circumstances.
- Nicole, thanks very much.
- All my pleasure, Kim.
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