Mortgages & Family Loans Explained Simply!
With the price of housing in Australia, our children are finding it more and more difficult to come up with the ever rising deposit needed to purchase a home of their own, leading to many parents lending their children money to help them get started. The question is, are they doing this to their own detriment?
Let’s look at an example:
Mr. & Mrs. Jones came to see me as they are going to lend money to their son for the purchase of a property. They wanted to know the best way to loan the money to protect them from loss.
Good question and very wise to deal with it before they made the loan.
In simple terms, people can lend money and not take security for the loan. That puts them in the same position as any other debtor that the borrower owes money to. They have no priority rating at law to have their loan repaid whereas, if they have formal loan and mortgage documents in place, they become “secured creditors”.
In most instances, secured creditors rate before unsecured creditors in law.
Let me explain further:
A mortgage is a legal document securing an interest in real property held by a lender as a security for a debt, usually for a money loan.
The word is a Law French term meaning "dead pledge." In the later Middle Ages the term was interpreted by folk etymology to mean that the pledge ends (dies) either when the obligation is fulfilled or the property is taken through foreclosure.
A mortgage itself is not a debt, it is the lender's security for a debt. It creates an interest in land (or the equivalent) from the owner to the Lender, on the condition that this interest will be surrendered to the owner when the terms of the mortgage have been satisfied or performed.
In most jurisdictions mortgages are strongly associated with loans secured on real estate rather than on other property (such as ships) and in some jurisdictions only land may be mortgaged.
A mortgage is the standard method by which individuals and businesses can purchase real estate without the need to pay the full value immediately from their own resources.
Mr. and Mrs. Jones were concerned as they were lending $20,000 and the bank was lending the rest. They should still have loan and mortgage documents in place in order to be secured creditors.
A mortgage is usually effective from the date of signing, not from the date of registration. Accordingly, you may choose not to register a second mortgage but you are not in as strong a position legally as you would be if registration is affected.
For example, you will not be able to exercise your power of sale to transfer the property to a third party unless your mortgage is registered.
If you do not register your mortgage over the property, the title will not show that you have an interest in the property. Consequently, you may lose priority to a third party who does register a mortgage or lodges a caveat against the property to secure other loans or obligations.
You should also consider entering into a priority agreement with the first mortgagee. This will limit the possibility of the first mortgagee providing further advances that will take priority over the loan which the second mortgage secures. The down side with this is that the first mortgagee may seek that their costs be paid for the Deed being created, & may also insist on further Deeds of Priority if they make further advances.
In all instances, however, you should seek appropriate legal advice to cater to your specific circumstances.
Mr. and Mrs. Jones are starting to think it is all too difficult so let’s look at the flip side where there is no formal loan documents and a mortgage for security.
In simple terms, you can choose to lend the money to your son and not take security for the loan. That puts you in the same position as any other debtor that your son owes money to and you have no priority rating at law to have your loan repaid. Not a good position to be in.
If for example Mr. and Mrs. Jones came to see me after the money changed hands, they are still able to complete loan documents.
If you have lent money to a family member without any formal documentation in place, maybe it is time to rethink your strategy to protect your capital.
Shane Ellis is the Managing Director of the Shane Ellis Legal Group & SMSF LawEquityProtect. He is a Senior Consulting Lawyer specializing in SMSF ESTATES & LAW, FAMILY ESTATE PLANNING, and Asset Protection Structuring & Business Structures.