With regulations on banks becoming more restrictive, and banks themselves refining their lending policies, not to mention the recent bull run on housing in New Zealand, when it comes to obtaining cash for a significant purchase, people are increasingly looking to other sources of liquidity. One such source that has been gaining increased media attention is the Bank of Mum and Dad.

According to Statistics New Zealand, the Household Savings Ratio[1] at the end of the March ’21 quarter was 0.4 (see the below table for the trend over the last two years). Couple this low savings rate with the burden of a student loan, increasing rents, and increasing prices, it can easily be seen how people are turning to their parents, who are likely to have a large amount of equity available in their home, to source this liquidity.  

Being able to borrow from your parents is positive in many respects; it allows future generations to benefit from accumulated wealth; opens the potential to borrow at a lower interest rate; enables the parents to pass down financial guidance to their children; and for the parents, the possibility of obtaining a higher interest rate than what they would receive for their hard-earned cash held on deposit with the bank.

However, whilst there are many positives, borrowing within families can be fraught with issues, such as misaligned expectations on repayment timetables, confusion as to whether the money is a gift or loan, fairness amongst siblings, and the ability for parents to call repayment if the funds are required.

As one would expect, these issues arise rather frequently, and as such, here are some of my thoughts on borrowing from parents, the circumstances under which I would borrow, and repayment.

But first, a brief on when I borrowed from my parents, the purpose of which was to fully repay my student loan and take advantage of the 10% repayment bonus.

For those unaware, the 10% repayment bonus was a government scheme which offered a 10% bonus to borrowers who made voluntary repayments of NZD500.00 or more on their Student Loan This scheme was introduced to incentivise the earlier repayment of loans (since repealed in 2012 as faster loan payments were not evidenced in data). This policy was introduced post a downward trend in voluntary student loan repayments after the introduction of interest free student loans in 2006.

When asking to borrow the money, I was keen to ensure that my parents and I were clear as to why I needed the funds, that I did not borrow any more than I needed, that we were both clear on this being a loan, that it would be repaid, the applicable interest rate, and that I would make regular payments.

Being of a financial mind, I was very keen to track the repayment of the loan, not only to ensure that I knew how much I was repaying, but also to ensure I was transparent with my parents about how much I had paid, and how much I had outstanding.

Given I was in London at the time I borrowed the money, and my parents were in New Zealand, I chose to keep track of the loan repayments via a spreadsheet. This way I could easily send the latest outstanding to my parents.

Post each payment, I would send this spreadsheet to my parents for them to check. To be honest, I am unsure whether they ever checked the spreadsheet, but I am sure that this gave them some comfort that all was in order; I also enjoy a bit of order, so this suited me OK.

The interest rate I applied was a margin above the existing Term Deposit rates offered by my parent’s bank. Given the alternative use of the cash for my parents would be to place a deposit with their bank, I felt this was an appropriate way to derive the interest rate which my parents agreed to.

I fully repaid the loan over a few years and was consistent with repayments. If there was an odd occasion that I was unable to make a payment, I would let my parents know and try to resume payments as soon as possible.

Overall, I felt this was a good result for both myself and my parents. It was positive for me in that I was able to reduce my financing costs, whilst it was positive for my parents in that they were able to increase the interest earned on their cash.

Now to my thoughts on borrowing from parents, and parents lending money to their children.

In terms of preference between borrowing from parents, and from a bank, if there are means, my preference would be to borrow within the family. However, I caveat this by saying that conditions should come with this borrowing.

Personally, I do not feel a loan should be extended in all circumstances, and in some situations a gift may be a better option. I feel a loan should be used for a significant purchase, such as a house, car, or as in my case possibly a student loan. I do not feel that a loan should be provided for unnecessary purchases, such as holidays or clothing items.

To the parents, given this is your money, you have the sole vote as to whether the purpose of the loan is an acceptable use of funds. Through the process of lending money, parents can guide their children on the right path to using money, and to challenge decisions. Gift or loan, your choice.

In terms of repayment, this should be set at the start, and adhered to. This ensures fairness between parents, and of course other siblings. It can be very easy to let payments slip, and then through no fault of anyone, the loan is placed at the back of everyone’s mind until it would be uncomfortable to raise the issue of payment again.

Further to the above, transparency can often be the best way to retain trust. Should the topic of borrowing money arise, it may be helpful to discuss as a family. Depending on how much liquidity parents have available, the benefit offered to one sibling may not be able to be repeated for another and as such, transparency will ensure everyone knows what the situation is and have their chance for input.

One final point for the parents to consider, is how any loan will impact your own plans if it is not paid back for some reason. If there is the risk of some impact on the parents retirement, this should be made clear to the children borrowing the money as a way to outline the need to stick to a repayment plan, and to make the children think about whether the money is really needed.

In summary, whilst I recognise that the Bank of Mum and Dad is not available to everyone, if it is available, I believe it is a positive one to utilise. Not only will both parents and children have the potential to either earn or pay at a more favourable interest rate, but it will also facilitate a discussion on money within the family and how to spend it. This creates an important educational opportunity which allows parents to espouse their spending habits, and views on finance. This can be even more important if the child has a partner, who can then learn how the family approaches the use of money, and how family money is managed which can set expectations in a healthy way.

A brief outline of family borrowing considerations:

• Why is the money being borrowed;
• How much is needed, and where will it be paid;
• Is this a loan or a gift;
• Are the siblings aware and supportive;
• What are the repayment terms, and applicable interest rate; and
• Will non-payment impact the parents financial stability.

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[1] Household saving falls in the March 2021 quarter | Stats NZ