Should you help your kids onto the ladder?
Life is tough for your average first-time buyer. Soaring house prices over the past decade has made home ownership a distant dream for many. And now that prices are back within reach, strict lending criteria mean only those with squeaky clean credit histories and savings to put down as a deposit can hope to get on the ladder.
The struggles facing first-time buyers mean many are turning to their parents for help raising the deposit or even qualifying for a mortgage in the first place.
Around 80% of first-time buyers aged under 30 are estimated to be receiving financial help from their parents, according to the Council of Mortgage Lenders (CML).
"The Bank of Mum and Dad remains an apparently important source of help for young first-time buyers,” says Paul Samter, economist at the CML. “Some mortgage products specifically reflect this fact, and again we may begin to see more products that echo this phenomenon."
If you are a parent keen to help your child achieve their homeownership ambitions then there are several ways you can do this. But before you get out the chequebook, think carefully about the financial consequences.
1. Stump up the deposit
With most lenders reserving their best rates for people who only need to borrow around 70% of a property’s value, it’s little wonder that deposits remain one of the biggest barriers for most first-time buyers.
This has always been an issue, but the housing market boom prior to the credit crunch saw many lenders offer buyers the chance to borrow 100% or more of a property. The resultant credit crunch, and drop in house prices, highlighted the risk of this type of lending, with thousands of homeowners now in negative equity as a result.
Lenders are now unwilling to lend to people without a deposit to put down, but for first-time buyers building up enough money to take their first step on the ladder is simply not possible.
This is where parents can really help. According to David Hollingworth, mortgage expert at brokerage London & Country, parents stumping up all or some of the money for their children to put down on a property is the most common way the Bank of Mum and Dad is coming through for first-time buyers. “Deposits are crucial at the moment, so this is the most popular way parents can lend a helping hand,” he says.
The fact that interest rates on savings accounts are so dismal at the moment means many parents feel they would rather use their nest-eggs to help their children.
Some parents see this money as a loan, and expect their offspring to repay it when they are able. However, if this is the case, all parties should sit down and have a serious discussion about when - and how - the loan should be repaid. Parents should also consider whether their children can afford this loan, especially considering they are taking out a mortgage as well.
Hollingworth points out that some lenders might take issue with you lending your children money, as this technically impacts their ability to afford the loan.
However, for most parents, repayment isn’t necessary, according to Colin Dale, head of residential lending at Skipton Building Society. “Most people give gifts on the basis that they don’t want it back,” he says.
There are still some important things you need to take into consideration before you give your child money for a deposit.
First of all, you need to ask yourself whether you can afford to give this money away – not just now, but in the future as well. While you may be financially secure at the moment, when it comes to retirement you may feel differently. “Circumstances can change very quickly after you retire, so you need to make sure you are in a position to provide for yourself before helping out your child,” says Dale.
If you need to borrow money in order to fund your child’s deposit, perhaps by taking out a loan or remortgaging your own home, then you should seek independent financial advice first. Ask yourself whether your child would really want to see you go without, or get into debt, just to help them onto the property ladder.
Secondly, if inheritance tax is an issue for you, then bear in mind that there are limits to how much money you can give away. General cash gifts of up to £3,000 each year are exempt from inheritance tax, but if you should die within seven years of this money being gifted away, this money will still be considered as part of your estate.
Finally, if your child is buying a property with their spouse or partner, or even a friend, then consider what would happen should that relationship later break down. “Many parents worry about this issue, so it’s worth taking legal advice in advance of buying to make sure every party knows what will happen to the property and the money gifted should things go wrong down the line,” says Hollingworth.
2. Be a guarantor
If your child has an adequate deposit to secure a mortgage, but is still struggling to borrow enough money to buy their first home, then you could help them out by becoming a guarantor on their mortgage. This means that, should they later become unable to pay the mortgage, you will be liable for doing so and the lender can chase you for the money.
Not all lenders will accept parental guarantors; Hollingworth says notable exceptions include Halifax, Nationwide and Cheltenham & Gloucester, which all see this type of lending as less risky.
“Being a guarantor can help boost the amount your child can borrow,” he adds. “They are still ultimately responsible for paying the loan, and their name is on the mortgage, but the lender knows you will step in to pay it if they can’t.”
The main consideration for parents is whether they can afford to take on responsibility for the loan should, for whatever reason, their child no longer be able to cope with it financially.
Lenders will assess whether you are ‘good for the money’ before they approve the mortgage, so you will need to declare your income and financial commitments.
Dale says: “When parents want to act as guarantors, we look at their income and their other financial commitments to judge their ability to be able to cover the mortgage should their children not be able to. We also advise they seek separate legal advice so they fully understand the financial consequences of guaranteeing a mortgage.”
The biggest risk with guaranteeing a mortgage for your child is that, should they default and start missing mortgage payments, you will be liable for the loan. This could also affect your own credit rating, potentially making it harder for you to borrow in the future.
This is a remote risk, says Dale, as families tend to try and make more of an effort to look after each other’s interests. However, the risk of redundancy during the current recession does mean it should be an important consideration.
Nationwide is one example of a lender that accepts parents as guarantees on mortgages. However, it will only consider close family members or people with a long-term relationship with the borrower as guarantors, and insists that they obtain independent legal advice first. It will also only consider the income of one guarantor, who must be able to show they can afford the whole mortgage in addition to their existing commitments.
Katie Moore, spokeswoman for Nationwide, says: “In general, the guarantor should ensure that they can afford to repay the loan - they would need to demonstrate that their own mortgage is near finishing or that they have sufficient income.”
With mortgage terms normally lasting 25 years, you should take your future plans into account as well – you may be able to afford to take on their mortgage now, but would you be able to in the future?
Equally, you should ask yourself whether boosting the amount your child can borrow is a good idea or whether it might leave them overcommitted.
3. Use your savings to offset their mortgage
If you have cash in a savings account but aren’t prepared to hand this over to your children, then there is another way. You could opt for an offset mortgage deal that links your savings to a mortgage – a lender will then deduct the savings from the amount owed, and interest will only be charged on the difference.
Higher-rate taxpayers will also benefit because the usual 40% wipeout on their accrued interest in a savings account doesn’t apply with an offset scheme.
Hollingworth explains: “Parents can use any savings they have to help keep their child’s mortgage costs down. While this won’t help people who aren’t able to get on the ladder in the first place, it is a good way to retain control of your money and still help out.”
While only a handful of lenders offer offset mortgages that allow someone other than the borrower to put up the money for the linked savings account, there are a few exceptions.
Lloyds TSB recently launched an offset mortgage aimed at first-time buyers with small deposits (just 5%) whose parents are willing to let their savings be offset against the loan. The deal requires the buyer’s parents, grandparents or friends to deposit 20% of the property's value into a linked savings account, which pays 3.5% for a minimum term of three years.
However, there are some important factors to take into consideration; for a start, parents must be prepared to tie up their money for at least three years, possible longer if the property has fallen in value.
The other problem with this loan is that Lloyds takes legal charge of the savings – so the money is essentially collaterial against the risk of the child defaulting.
If this sounds too risky, then you might be more interested in Yorkshire Building Society’s Offset Plus mortgage, which allows up to two savings accounts to be offset against the mortgage.
Rachel Gladman, spokeswoman for the Yorkshire, says this is a viable alternative to lending your children money or acting as a guarantor as there is no risk to your savings should they default on the loan.
“We have no legal charge of the savings used to offset the mortgage, so if the borrower defaults we will ‘chase’ them rather than the parents,” she explains. “Although parents won’t earn any interest on their savings, they will be able to help erode the total cost of their child’s mortgage.”
If your child simply cannot afford to get on the property ladder – even with your help – then you could consider buying a second property yourself and allowing them to live there, rent-free or otherwise. This option is especially common among parents whose children are going to university.
There are obvious benefits for parents; as well as helping their child, they also have the potential to earn an income from the rent, and assuming they retain the property for a certain period of time, they could also make a capital gain.
But this option should not be entered into lightly. Buying a buy-to-let property should be seen as a long-term investment, and (unless you have the cash to buy one outright) might also mean taking on more debt in later life.
“This is a long-term commitment, and the ultimate motive for doing this should be to invest in property,” says Hollingworth. “If your child later wants to move out, you may need to rent it out to strangers, and take on all the advantages and disadvantages of being a landlord.”
Of course, you could sell-up when your child decides to move out, but this leaves you at risk of making a capital loss on the property.
There are also tax implications in buy-to-let; for a start, you face paying income tax on the rental income, and as the property isn’t your main residence, you also face paying capital gains tax when you come to sell. It will also be counted as part of your estate for inheritance tax purposes.
There are a number ways to mitigate your tax liability and it's worth speaking to an independent financial adviser for advice.
Finally, getting a buy-to-let mortgage isn’t as easy in the current climate as it has been in the past. Fewer lenders offer this type of loan, and rates can make it an expensive way to borrow. Plus, because you’ll be renting to a family member, your mortgage will be regulated (most buy-to-let loans aren’t currently regulated by the Financial Services Authority) which might mean less choice of competitive products.
5. Buy together
Last but not least, one option for parents is to go in with their child and buy a property together. This means using your collective income to take out a joint mortgage, with all the relevant names on the deeds, and sharing responsibility for making the repayments.
If you would rather not have your name on the mortgage, then you could help out by paying part of your child’s monthly repayment – but this will not help them onto the ladder, as lenders won’t take this ‘income’ into account.
Taking out a joint mortgage should never be entered into lightly. You’ll need to go over the terms of the arrangement very carefully – just because you are family members doesn’t mean you shouldn’t take measures to protect yourself financially. For example, you are jointly responsible for paying the loan, so if your child stops paying, then you will have to take on the full debt or risk defaulting and potentially losing the home.
You also need to think about what would happen to the property should you or your child die, and make sure you take out the right type of tenancy agreement for your needs. If you are 'tenants in common' – i.e. you both own a stated share of the property – then the share of the deceased passes to their estate and could be claimed by a benefactor in the will or, if relevant, their creditors. Unless you are able to negotiate with whoever is owed this money, then you may have to sell the property.
The other option of becoming 'joint tenants' – i.e. you own the whole property together – means the deceased person’s share passes to the other person, and becomes part of their estate. For debt purposes, this means that creditors are less likely to be able to force you to sell up.
If one of you dies, there is also the issue of paying the mortgage. When taking out a joint mortgage, it’s important to look at your life insurance arrangements and review whether these need to be changed in light of the mortgage agreement.
Unless you also live in the property, it won’t be considered as your main residence for capital gains tax purposes, so again you face a tax bill when you come to sell. Inheritance tax could also be an issue.
Dale says: “We would advise people against this option, not least because of the tax implications.”
Before buying a property with your child, you should all seek independent advice, and get suitable legal documents drawn up so that everyone knows what will happen if one party wants out or should things go wrong.
Tom Moran, partner at law firm Speechy Bircham, says parents buying a property together with their child or children should get a trust deed (also known as a deed of trust or a declaration of trust) drawn up.
This stipulates what share every party has in the property, and what proportion of the mortgage they are responsible for paying. It will also set out what will happen if one party wants to sell and disputes arise.
"All parties sign this document when the purchase goes through to ensure their interests and assets are protected," he explains. "This is a robust document that provides a good armour for all involved."
Questions to ask yourself before helping your child:
* What do you want to achieve?
* What are the inheritance tax implications?
* Will I need the money in the future?
* How long can I afford the risk of guaranteeing my child’s mortgage? Will I still be happy to do so once I’ve retired?
* What would happen if my child was to become involved with someone I don’t approve of, or if their current marriage, civil partnership or relationship were to break down?
* Will I be liable for capital gains tax when it comes to selling the property?
The circumstances in which a property is worth less than the outstanding mortgage debt secured on it. Although it traps householders in their properties, the Council of Mortgage Lenders (CML) says there is no causal link between negative equity and mortgage repayment problems. At the depth of the last housing market recession in 1993, the CML estimated 1.5 million UK households had negative equity but most homeowners sat tight, continued to pay their mortgages and eventually recovered their equity position.
A way of combining a mortgage and savings so the savings “offset” and reduce the mortgage. Rather than earning interest on savings, the savings reduce the mortgage and the interest paid on the borrowing, so savings are effectively earning interest at a higher rate than most mainstream savings accounts will pay. They are also tax-efficient, as savers avoid paying tax on interest that their deposits would otherwise have earned. Offset mortgages offer the disciplined borrower a great deal of flexibility, as overpayments can be made to reduce the term or monthly mortgage repayments, which can save thousands of pounds in interest payments over the mortgage term.
Changing mortgages without moving home. Property owners chiefly remortgage to get a better deal but some do so to release equity in their homes or to finance home improvements, the costs of which are added to the new mortgage. Even though you’re not moving house, you still need to engage solicitors, conveyancing and the new lender will require the property to be surveyed and valued.
Generally thought of as being interchangeable with life assurance, but isn’t. Life insurance insures you for a specific period of time, at a premium fixed by your age, health and the amount the life is insured for. If you die while the policy is in force, the insurance company pays the claim. However, if you survive to the end of the term or cease paying the premiums, the policy is finished and has no remaining value whatsoever as it only has any value if you have a claim. For this reason, life insurance is much cheaper than life assurance (also called whole of life).
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.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.