One bank helped to finance a quarter of all mortgage transactions last year. Collectively it co-funded 306,000 property deals, with an average of £17,500 each. Its total lending of £77 billion made it the UK’s ninth-biggest personal housing finance provider, on a par with the Yorkshire Building Society.
You won’t see any branches in the high street, but you may know its name. It’s the so-called BoMad, the Bank of Mum and Dad – or, just as frequently, BoGran, the Bank of Gran – family members who give or lend cash to children and grandchildren.
A new survey for Saga by Populus has found 66% of respondents were considering, intending to, or had already given substantial financial gifts to their grandchildren. A range of reasons were given, from funding university education, a holiday or a house purchase. Some 39% said they intended the money simply as a gift to spend on whatever they liked. Two in five called their gift an early inheritance…
So if you decide you want to help a family member for the largest purchase they will make – a house – what is the best way to go about it? Give or lend? What about tax? What if you need your money back?
Follow the ‘emergency oxygen’ rule
On board an aircraft the emergency instructions tell you to put your own oxygen mask on first before assisting a child or other passengers. This is the rule to remember above all when helping grown-up children or grandchildren.
Make sure you are provided for and secure for the years ahead before you assist others. Otherwise, generosity can turn sour and land both parties in financial straits down the track.
Give or lend?
Giving money is invariably better. It is less complicated and may have tax advantages. Realistically, however, for many lending may be the only option.
Whatever you decide, make sure the terms of the gift or loan are clear. Distasteful as it may seem within a family, putting everything down in writing is not just sensible, it’s vital. The Saga survey found that 27% of those who had lent money to grandchildren hadn’t discussed how it would be repaid.
Even better is having a legal agreement drawn up, particularly where third parties are involved or could become involved in future – for instance, an offspring’s partner.
Options for parents
A lump-sum gift
Giving spare cash that is lying listlessly in a low-interest savings account should be relatively straightforward, although the ‘emergency oxygen’ rule applies.
Pitfalls: Underestimating your own needs and forgetting to leave yourself sufficient funds for anything unexpected happening. Failing to consider the needs of the survivor if one parent dies.
In the event of a grown-up child being declared bankrupt or being involved in a relationship break-up, the money you have given could become forfeit to a creditor or could become part of a divorce settlement. Take legal advice on minimising the risk.
Releasing cash by selling investments or liquidating a pension fund could incur tax charges. If you don’t live for seven years after making the gift, it could be subject to inheritance tax.
Mortgaging your own home
Getting a mortgage and using pension income for repayments has become much easier for older people, as has extending an existing mortgage into retirement. If you remortgage your own home to release capital to give to your child, you can then either make bigger monthly repayments or you could extend the term, if that’s permitted.
Pitfalls: You may find yourself unable to make the repayments at a future date, which could put your own home at risk.
A joint mortgage with your child
You and the child own the property together, giving you greater control over ownership, management and eventual sale.
Pitfalls: The term of the mortgage may be short because of your age, to ensure that it complies with the lender’s rules, making monthly payments more expensive.
Affordability checks would include your income as well as your child’s and, importantly, include any loan outstanding on your own home.
You might impair your ability to borrow in future – such as for improvements to your own home – because your credit record could imply you were overextending yourself.
Since your name would be on the mortgage deed you would also be personally liable for keeping up the repayments if your child could not. Also consider whether you could cope with an interest-rate rise.
If you already own your own house, the home you buy with your child would count as a second property, which means it would incur an extra charge of 3% over and above the normal stamp duty tax on the purchase value.
Capital gains tax might be payable if you sell up, as the child’s property co-owned with you would not be your principal private residence and therefore not exempt.
A guarantor mortgage
With a guarantor mortgage, the child buys the property in their own name, but the parent provides security by means of a cash deposit or a property, which becomes forfeit if the child defaults on the loan. This sort of security allows the child to borrow more, or at a better rate than the lender’s affordability criteria would otherwise permit. There are various ways of doing this:
Cash deposit: The parent deposits funds with the bank that is lending to the child. The funds remain the property of the parent and they receive interest on them, as with any other savings account.
Charge on parental home: Again, the parent retains ownership of the home but the lender has a charge on it in case the child defaults.In both cases the funds held as security are released or the charge on the parental home is removed as soon as the child has made sufficient repayments on their mortgage to meet the lender’s standard borrowing requirements.
An offset mortgage: The parent deposits funds with the lender and, instead of receiving interest on their savings, it is credited against the mortgage debt of the child, helping them to make bigger or faster repayments.
Pitfalls: While funds deposited in a guarantor mortgage remain yours, they are tied up during the period of the guarantee, so are not available for other expenditure. Likewise, if your house is tied up as security for your child’s loan you wouldn’t be able to sell it or move.
If the child defaults, you could lose your savings or your home unless you can find funds from another source to meet the debt and release the charge.
Lending without strings
Many parents lend their children a lump sum, either with a repayment schedule or on a ‘pay me back when you can’ basis.
Pitfalls: Informal lending is popular, but anyone doing it should be prepared for family strife if the loan is not repaid as planned or the terms of repayment are not clear.
A schedule for repayments should be drawn up or a trigger event established, such as ‘when the property is sold’.
If you lend money to a child to help them obtain a mortgage, the child will need to declare this to the mortgage lender. Many lenders won’t allow other loans against a property or, if they do, they will include the parental loan in affordability calculations – which means they would potentially lend less than if the money were a gift.
Lenders may ask you to sign a declaration of the money’s status as a gift or a loan. Don’t be tempted to lie, as this would constitute fraud.
A private mortgage
You could offer a loan secured against the property in exchange for monthly repayments, just like a bank.
If the child defaulted on the payments, you would assume ownership of the property.
Pitfalls: If you charge interest on the loan, it will be liable to income tax. Capital gains tax could be payable on the sale of the property. You need to take advice on how to structure the deal to minimise tax.
You need to consider how you would enforce repayment if a child defaults. Would you really repossess your child’s home?
Options for grandparents
A lump-sum gift
The same rules apply as for parents: look after your own interests first. Giving a grandchild an ‘early inheritance’, however, can be inheritance-tax (IHT) efficient. A lump sum would be a potentially exempt transfer, as long as you survived seven years after making the gift.
Similarly, making regular payments out of income as a gift to the child – topping up mortgage payments – can also be IHT-effective as long as your capital is not depleted or standard of living affected.
Pitfalls: If you don’t live for seven years, a lump-sum gift could be included in your estate.
Gifts could affect your own or your grandchild’s entitlement to benefits. This is particularly true if you might need long-term care in later life. Gifts could be regarded as ‘deliberate deprivation of assets’ – that you are offloading cash to qualify for means-tested benefits. There is no cut-off date as there is with IHT (the ‘seven year rule’), so always take advice.
Though useful in many cases, this is seldom the best option for releasing cash and should be considered only after taking advice. However, older people may wish to release equity from their homes to pass on money to grandchildren before their death, and it can be a useful tool in inheritance planning.
Pitfalls: Downsizing is invariably a preferable way of releasing capital, as equity release may limit your options at a later date – such as moving to sheltered accommodation. Be cautious and take advice.
Interest rates on equity-release products with the ‘safe home income plan guarantee’ – which ensures the debt, with interest rolling up, will never exceed the value of the property – may be more expensive than other types of borrowing. Deliberate deprivation of assets rules may apply.
Lending to grandchildren
A loan, repayable monthly just like a mortgage, could provide you with an income stream similar to a monthly interest savings account with a building society. This could be an ideal scheme for an earnings-rich, security-poor grandchild – for instance, a highly paid contract worker who might find it difficult to meet a bank’s affordability criteria, but has plentiful work with high wages.
Pitfalls: You would be taking the same risk as any bank that has declined to lend to your grandchild on the grounds of job security. How would you cope if their income declined or a granddaughter needed to take unpaid maternity leave? The income could affect your entitlement to benefits, and if you charge interest it could be liable for tax.
If you are entering into an agreement where family money could be at risk, always take legal advice and make sure everything is in writing to avoid expense and heartbreak later. Putting yourself first is not being selfish, it is common sense.
Subscribe today for just £3 for 3 issues…