New research from Legal & General has shown that more homebuyers than ever are relying on their parents, and indeed grandparents, to help fund the cost of their first or new home.
In fact, if the ‘Bank of Mum & Dad’ were an actual bank of building society, it would be the 10th largest mortgage lender in the country.
As house prices continue to rise, we know the temptation to help your children or grandchildren buy a home can be overwhelming. But, making a hasty decision based on emotion, before you have thought through all the pros and cons, can be dangerous and leave you financially exposed in the future.
Here are six things you should think about before you open the ‘Bank of Mum & Dad’ for business.
#1: Loan or gift?
One of the first decisions you need to make is whether you help your children out by making an outright gift, or a loan.
Clearly a gift has advantages for your children; they don’t have to pay it back! But, there are obvious consequences for you, for example:
- Can you afford to reduce your capital?
- How will it affect your ability to pay your bills in the future?
- Are there large, one off expenses, which you need to meet in years to come, which you may now not be able to do?
A loan means, in theory at least, you will at some point in the future be repaid. You may feel uncomfortable, even mean, by offering to make a loan rather than a gift. But, it may suit both you and your children; they get the leg up onto the housing ladder, whilst you know that you will be repaid in the future.
#2: Loan: Interest free or not?
If you decide to make a loan, we would always suggest formalising the arrangement. You may have no intention of falling out with your son or daughter, but what about their husband or wife? Especially if their marriage unfortunately ends up in divorce.
A formal agreement may feel unnecessary now, but can be very valuable in the future.
If you decide making a loan is the best option there are a number of other things to consider, for example:
- Will you charge interest? If so at what rate and how will it be calculated?
- Will you accept repayment of the loan at some unspecified date in the future, possibly when the house is sold, or do you want it repaid over a set number of years, in the same way a personal loan or a mortgage would be?
- How frequently will payments of interest (and perhaps capital) be made to you?
- Do you want to take a second charge on the property your son or daughter is buying? This means that when the house or flat is sold the loan to you must be repaid; assuming of course there is sufficient equity in the property to do so
Remember too, if you receive interest on the loan this needs to be declared and is potentially taxable; reducing your return and creating additional administration.
#3: Can you afford to give up access to your capital?
If a loan doesn’t appeal, you may of course prefer to make an outright gift. Before you do though, we would recommend you take independent financial advice to confirm that this is the right option and that it will not leave you financially vulnerable in the future.
Again, a formal agreement may be sensible, in fact some mortgage lenders may insist upon it, to make the details of the arrangement clear.
#4: Could a give help reduce tax?
If after taking advice, you decide that making a gift is the right option you could turn this to your advantage.
If your estate is above the Inheritance Tax (IHT) threshold, currently £325,000 in the current tax year (effectively doubled to £650,000 for married couples and civil partners) making a gift could help reduce the amount of IHT payable on your death.
Whilst there are specific gifts you can make which are immediately outside of your estate, these are probably of little significance, because most ‘withdrawals’ from the ‘Bank of Mum & Dad’ are in excess of this amount. However, if you make a larger gift and live for more than seven years, it falls outside of your estate when you die, potentially saving your beneficiaries, who are often going to be your children, a significant amount of tax.
#5: Where does the money come from?
Whether you are making a loan or a gift you need to decide where the capital will come from. To put it another way, which savings or investments will you use to help your children?
As a rule of thumb you should take the money from the least tax-efficient ‘pot’ you have, but that can sometimes be tricky to work out, especially after the introduction of the Personal Savings Allowance back in April.
Again, we would recommend you take advice before deciding where the capital should come from.
#6: What are the alternatives?
There may be other options, which will help your children get onto the housing ladder, but won’t require you to make a loan or a gift.
Many mortgage lenders have come up with innovative solutions to the difficulties facing younger generations. We would always suggest you take advice, or speak with your children’s mortgage adviser, to investigate all options.
We’re here to help
If you are thinking of helping your child or grandchild buy a new home, but you would like to know more about the options available to you, we are here to help.
Call Sarah or Bev on 0115 933 8433 or email firstname.lastname@example.org
Please note: The Financial Conduct Authority does not regulate Inheritance Tax Planning