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I am looking for the potential pitfalls I could be about to fall in, and ways to mitigate them. I live in Australia.

My fiancee and I have roughly $100k in savings, which we want to use to buy a house in a few years.

My parents own two houses - their own home, which is paid off, and an investment property, which still has a significant mortgage. They aren't struggling to make their repayments.

I am considering using a significant portion of our savings (earning roughly 2.8% p.a.) to loan to my parents (paying roughly double in interest rate) at an interest rate that allows us all to benefit.

My parents have a loan that allows both additional repayments and withdrawals (up to the amount of extra that has been paid) with no penalty.

Some potential issues I have thought of:

  • This may effect how much, or under what terms a bank is willing to loan us. I imagine a bank would be more inclined to trust someone who has earned and saved their own money than someone who, on the surface, has been given a large sum by their parents. Although presumably only the bank I have the savings account with would even be capable of seeing this?

  • The money could not return. I trust my parents, but I'm obviously going to get something in writing. Is it worth getting something by a lawyer, or can I just write something simple myself and have everyone sign it? If both of my parents were to pass away before the money is returned, would that document be enough to ensure that the loan is returned promptly?

  • Tax implications: Will this count as taxable income for me? And if so, presumably my parents can still count it as a tax deduction?

  • Property prices collapse, and my parents aren't able to make their repayments, bank forecloses on the place and sells it, but not even enough to cover the outstanding loan, meaning my parents no longer have our money. (I could of course double down and pay their monthly repayments for them in this case).

So my questions:

  • Any other risks I have missed?

  • Any mitigations for any identified risks?

  • Anything I flagged as a risk that is not actually an issue?

  • Assuming you would advise doing this, what fraction of savings would you recommend keeping as a rainy day fund that can be accessed immediately?

  • This seems more to be a question about Australian laws governing loans and estates than about issues of personal finance. Please consider asking the moderators to move the question to law.SE. You can contact the moderators by clicking on the flag link below your question. – Dilip Sarwate Nov 15 '15 at 22:52
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    I think the question is on-topic here. – Ben Miller - Reinstate Monica Nov 15 '15 at 23:33
  • @ Dilip - that may be the case. I honestly don't know what implications there are with me making this decision. It may be that there are no financial impacts, but there are significant legal implications, in which case my question is in the wrong thread. I identified 4 potential issues, of which three are finance, and one (admittedly maybe the most significant one) is legal, so I posted to this site instead of law. – Scott Nov 16 '15 at 0:03
  • Sell the rental, voila! If they are having trouble paying then what happens when they have trouble paying you? Bad mojo. – AbraCadaver Nov 17 '15 at 16:12
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    @ Abra - they aren't having any trouble with their mortgage repayments. I am talking about extra repayments well over the minimum threshold, and this is purely about cutting out the middle man of the bank who effectively borrows money from me at a low rate and lends that money to my parents at a higher rate. – Scott Nov 17 '15 at 20:35
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This may effect how much, or under what terms a bank is willing to loan us

I don't think this is likely, an investment is an investment whether it is money in a savings account or a loan. However, talk to your bank.

Is it worth getting something by a lawyer?

Definitely, you need a lawyer and so do your parents. There is a general presumption at law that arrangements between family members are not meant to be contracts. You definitely want this to be a contract and engaging lawyers will make sure that it is. You also definitely want this to be a proper mortgage so that you get first call on the property should your parents die or go bankrupt. In addition, a lawyer will be able to advise you of the pitfalls that you haven't seen.

If both of my parents were to pass away before the money is returned, would that document be enough to ensure that the loan is returned promptly?

No, see above.

Tax implications: Will this count as taxable income for me? And if so, presumably my parents can still count it as a tax deduction?

Definitely, however the ATO is very keen that these sorts of arrangements do not result in tax minimisation. Your parents will get a deduction at the rate charged; you will pay tax on the greater of the rate charged or a fair commercial rate i.e. what your parents would be paying a bank. For example, if the going bank mortgage rate is 5.5% and you charged 2% they get the deduction for 2%, you pay tax as though they had paid 5.5%.

Property prices collapse, and my parents aren't able to make their repayments, bank forecloses on the place and sells it, but not even enough to cover the outstanding loan, meaning my parents no longer have our money. (I could of course double down and pay their monthly repayments for them in this case).

First, property prices collapsing have no impact on whether your parents can pay the loan. If they can it doesn't matter what the property is worth. If they can't then it will be sold as quickly as possible for an amount that covers (as far as possible) the first mortgagee's indebtedness.

It is only in reading this far that I realise that there will still be a bank as first mortgagee. This massively increases the risk profile.

Any other risks I have missed?

Yes, among others:

  • What are you going to do (really) if your parents don't pay?
  • What happens if the property burns down?
  • What happens if the property burns down and your parents forgot to pay for insurance?
  • What happens if your parents divorce?
  • What happens if it is a really messy divorce and your father deliberately burns the house down meaning the insurance won't pay and he goes to jail?
  • What happens if your siblings believe that this is an insidious plot to damage their inheritance?
  • What are you going to do if your wife gets pregnant?
  • What are you going to do if you want to buy a house in 2 years?
  • What are you going to do if you get diagnosed with cancer?
  • In short, what is your exit strategy?

Any mitigations for any identified risks?

Talk to a lawyer. Talk to an accountant. Talk to an insurance professional.

Anything I flagged as a risk that is not actually an issue?

No

Assuming you would advise doing this, what fraction of savings would you recommend keeping as a rainy day fund that can be accessed immediately?

I wouldn't, 100%.

  • 100% agree. I wouldn't and I wouldn't take a loan from my kid. Sell it. – AbraCadaver Nov 17 '15 at 16:14
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I don't know anything about Australian tax law, the Australian real estate market, or your parents' ability to repay the loan. However, no matter what the answers to those questions are, I do not recommend that you go through with this.

The reason is the risk. Usually, with an investment, you are risking the money that you invest. However, with this investment, you are not only risking the money; you are also risking both you and your fiancé's relationship with your parents.

If your parents have trouble paying back this money in a few years when you need it for your house, how will that affect how you feel about your parents? How will that affect how your fiancé feels about them? It will make family gatherings very awkward for everyone at least.

Don't put family harmony at risk for the sake of an extra 2.8% return. There are other ways to invest that risk only money.

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