Beware the dangers of lending to family members
If you had a spare £40,000 would you give it to a total stranger? Nobody in their right mind would. For a start we don’t know anything about the person, we run the risk of losing it all and where do we stand when it all goes wrong?
So why do we as parents or even grandparents give our offspring thousands of pounds to help them with the deposit to buy a house? We think because we know them we’ll always get our money back if it goes wrong. But are you sure about that?
Why the need for a loan?
Gone are the days of a 100% mortgage. Remember Northern Rock and its infamous ‘Together loan’ product offering 125% loan to value (LTV). These days the mortgage lending market is extremely tight and the majority of the products available require a very healthy deposit.
First-time buyers can be asked to find between 10% and 30% of the home value to qualify for a mortgage offer. The greater the deposit the lower the risk to the lender - which also means a better interest rate for the borrower.
So for example, a borrower wishing to buy a property valued at £200,000 will have to find between £20,000 and £60,000 as a deposit.
Luckily for some, their parents or grandparents stump up the cash. But this is where it gets scary: they often just transfer the funds into their relative’s bank account without giving a second thought to protecting their money.
So what can go wrong?
Let’s use Tom as an example. He is given £40,000 by his family for a deposit and over the next few years uses his credit cards to meet some bills. He falls in and out of work and his finances get in such a mess that eventually he is made bankrupt.
When a person is bankrupt they no longer have a requirement to repay their unsecured lenders, this being credit and store cards, overdrafts or personal loans, so they no longer have any debt issues.
However any asset owned at the time of going bankrupt is immediately transferred to the Official Receiver (OR) and this will include the house Tom put his £40,000 deposit on.
In Tom’s case any equity he had at the time of going bankrupt will now belong to the OR. After necessary expenses to administer the bankrupt’s estate the remaining funds from selling the home will be distributed to those lenders that were part of Tom’s bankruptcy.
Tom’s parents or grandparents now become one of those unsecured lenders in the bankruptcy. If there was enough money from the bankruptcy to give the lenders say 10p for every pound owed then Tom’s family would get £4,000 back on their £40,000 and that’s it!
The situation would be slightly different if the deposit was held in joint names and only one party was going bankrupt as the other un-bankrupt person would be entitled to half the deposit so the equity available to the OR would be halved. Still rather a lot of money to lose!
How to protect the deposit
It’s relatively simple really, just contact a solicitor and say you wish to register a charge on your family member’s home to protect your investment. Costs will vary from £75 - £175 depending on who you use, but it’s a small price to pay to protect your investment in the long run.
I would also suggest you consider adding interest to the sum borrowed so that if there’s an issue some years later, you will be able to claim for the increased value.
What will the children say?
The beneficiary of the loan may not be too pleased to have the charge on their house, but a high street lender would do the same so why can’t you? Put yourself in the bank’s position: ‘’These are my terms and conditions - do you want help in finding the deposit or not?”
No one knows what’s around the corner; life has this funny way of dropping things out of the blue. So make sure you protect yourself now, because hindsight is 20/20.
Loan to value
The LTV shows how much of a property is being financed and is also a way to tell how much equity you have in a property. The higher the LTV ratio the greater the risk for the lender, so borrowers with small deposits or not much equity in the property will be charged higher interest rates than borrowers with large deposits. The LTV ratio is calculated by dividing the loan value by the property value and then multiplying by 100. For example, a £140,000 loan on a £200,000 property is a LTV of 70%.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.
A person (or business) unable to pay the debts it owes creditors can either volunteer or be forced into bankruptcy – a legal proceeding where an insolvent person can be relieved of their financial obligations – but loses control over their bank accounts. Bankruptcy is not a soft option. Although it may wipe the financial slate clean, it is extremely harmful to a person’s credit rating (it will stay on your credit record for six years) and will adversely affect your future dealings with financial institutions. Bankruptcy costs £600 paid upfront.