In recent years, the rise in house prices has meant that many first-time buyers have struggled to get onto the housing ladder and have had to rely on help from friends and family. According to a survey published in the Guardian, the average first-time buyer will be loaned around £20,000 from loved ones.
Lending money from the “Bank of Mum and Dad” can be a great way to help your children but there are also several things you need to think about before you do. Read on for the five things to consider before becoming the Bank of Mum and Dad.
1. Make sure your assistance doesn’t impact you financially
As a parent, it’s very normal to want to help your children when they fly the nest and decide to buy their first home.
While helping your loved ones onto the property ladder can be a great way to help them, you also need to think about your own financial security. Can you realistically afford to part with thousands, or tens of thousands, of pounds?
Even if you feel financially secure now, such a large gift or loan may have an impact on your finances in the near future.
Think carefully about how much you can realistically afford to give when helping your children. If handing over that money will significantly impact your quality of life or your financial goals, you should think twice.
2. Formalise your lending to prevent disputes with loved ones
If you review your finances and find that you can help your children, one of the most important things you can do is to formalise your lending.
In most cases, families tend not to keep written records of their transactions when lending from the Bank of Mum and Dad. Many more don’t even discuss whether the money is a gift or a loan.
This may not be surprising, especially since some people still consider it taboo to talk about money, but failing to get it in writing can have serious consequences. In a worst-case scenario, if you don’t have a written agreement, you may be forced to take your child to court to get your money back.
According to a study by the London School of Economics (LSE), around a quarter of people whose parents had helped them out financially had been loaned the money rather than being gifted it. If you plan to loan money to your child, you should decide whether you want to organise a formal repayment plan or a more flexible arrangement.
While this might seem unnecessary, formalising the agreement can help you if you run into problems down the line and can help to defuse arguments before they get heated.
3. Talk to your child about a Living Together Agreement if they have a partner
If your child is living with a partner, it’s easy to worry that your financial aid won’t end up with them. For example, you may be concerned about what would happen if they were to break up after you had loaned or gifted them money.
The most prominent example of this scenario, reported in the Times, involved a couple who spent £380,000 in legal fees during their son’s divorce to prevent his partner being awarded half of the house that they had funded.
Ultimately, they were unsuccessful in the case due to their lack of documentation. Not only was their soon-to-be ex-daughter-in-law granted half of the value of the house, but the couple had to cover the full cost of her legal fees.
Furthermore, according to research carried out by NFU Mutual, almost half of parents say that their lack of trust in their child’s partner has affected their willingness to gift money.
If you’re concerned that gifts to a loved one might not end up with them, you may want to seek professional help to draw up a binding agreement.
Talking to your child about a Living Together Agreement for them and their partner can be a good way of tackling this issue.
This agreement is a written record of “who owns what” in a shared house and can be a good way to encourage your child to sit down with their partner and talk about their finances.
Alternatively, if your child and their partner want to marry, you could get them to set up a prenuptial agreement, which will set out how their assets will be divided if they were to divorce.
4. Bear in mind that your gift may have tax implications
Although neither you nor your child will have to pay any immediate tax on gifted money, your estate could be liable for Inheritance Tax further down the road as a result.
In each of the 2020/21 and 2021/22 tax years, you can gift up to £3,000 without this value being added to your estate. You can also carry any unused annual exemption forward for one year. This means that two parents may be able to gift up to £12,000 without having to worry about Inheritance Tax complications.
If you decide to give more than this and then pass away within seven years of making the gift, the money will form part of your estate when working out your Inheritance Tax liability. If the gift brings the value of your estate above the Inheritance Tax nil-rate band, it could be taxed up to 40%.
Another issue to be wary of is Stamp Duty. Some parents choose to help their child buy a house by taking out a joint mortgage with them. However, if you already own a property, your child’s house will count as a second home and you could be liable to pay extra tax on the purchase.
One way to avoid this issue is to take out a “Joint Borrower, Sole Proprietor” mortgage. This can enable you to be a mortgage borrower without being named on the title of the property.
The Financial Conduct Authority does not regulate Estate Planning. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
5. Seek professional advice before you make a payment
According to a study by the LSE, a significant number of parents had to re-assess their finances in order to help their child get onto the housing ladder. Of these, around 17% had to dip into their pension savings to do so.
While this is an admirable gesture, taking too much money from your pension may result in a much lower quality of life in retirement and have severe tax implications. Whilst a quarter of the fund can typically be taken tax free, the remaining 75% is taxed at your marginal rate. This could place you into a higher tax bracket.
Seeking professional advice before you help your child can help ensure that you can assist them as much as possible while not impacting on your progress towards your own financial goals.
Get in touch
If you want to help your child to get onto the property ladder but are concerned about how it could affect you, get in touch. Please email info@investmentsense.co.uk or call 0115 933 8433.
