Getting the next generation on the property ladder
According to data from a report from Lloyds Bank, lending from parents to their offspring to help get them on the property ladder amounted to £8 billion last year. The Family Building Society claims that if parental contributions were combined into a formal business, it would be the UK's sixth largest Lender.
This is hardly a surprise: it is estimated that the so-called ‘Bank of Mum and Dad’ will help to finance around a quarter of mortgage transactions this year. Following the relaxation to the pension rules a few years ago which allow parents and grandparents greater access to their pension pots, this is a figure that may only increase.
For parents, or grandparents, looking to help the next generation on to the property ladder, some creative thinking is often required.
The simplest option is to just make an outright gift to the buyer. This can assist in inheritance tax planning and may enable the buyer to obtain a mortgage at a better rate as it will increase their deposit. The difficulty with this option is a lack of control. Is the buyer financially responsible? Is the buyer making the purchase with a friend or partner they may not approve of?
Some family members may prefer to lend to the buyer. The buyer will be obliged to declare the source of their funds to their solicitor and the mortgage company which may impact on the mortgage rate they are offered. The advantage of a loan is that the money is due back to the lender at a later date. There is also the opportunity for the lender to protect their interest with an appropriate restriction on the land registry title.
Equally, the loan can be converted to a gift at a later stage if the buyer is deemed to be responsible. Again, a degree of caution is required, as even if the interest is secured on the property, the mortgage company will insist that their loan will take priority. So, if the owner defaults on their mortgage, the mortgage company will recover their loan and costs before any private lender. Conversion of the loan to a gift has to be done by deed in order to be effective in law and to start the clock counting for inheritance tax purposes.
It is worth thinking about how the loan is reflected: is it expressed as a fixed sum? Is interest to be charged? Is it to be a percentage of the property? The nature of how property is held will have an impact on taxes such as capital gains tax. It is essential that any agreement is accurately recorded in a declaration of trust to avoid any future misunderstandings and the Stamp Duty Land Tax implications may also need to be considered.
Joint mortgage or guarantor
An option, if funds for a deposit are not available, is for a family member to be party to a loan to guarantee that the mortgage is paid. Alternatively one may agree to be listed as a co-owner and therefore also on the mortgage.. Some lenders are increasingly offering specialist mortgages which allow a parent to have their name removed after a fixed period. As ever, each party to such a transaction should obtain their own independent legal and financial advice to ensure they are entering into any agreement with their eyes wide open.
Such agreements are not to be undertaken lightly. If the child or grandchild divorces or runs into financial difficulty and cannot pay the mortgage the mortgage company can turn to the guarantor or co-mortgagee for the outstanding payments and in the worst case, the entire outstanding balance. In turn, the financial security and credit rating of the lender could be adversely affected.
There is a word of caution: recent changes to the rules around stamp duty will have impact on how parents choose to provide financial support to their children’s home purchases. A three percentage point residential property surcharge in respect of stamp duty was imposed on people buying second properties including landlords, on 1 April 2018 in England, Wales and Northern Ireland. These changes could affect those who only purchase a minority share in the property. Stamp duty has been abolished in Scotland, but similar tax increases were also introduced there to prevent distortions in the housing market. Families should take advice from their advisors to ensure they are not caught out by these changes.
It is only natural that parents and other family members should want to help the younger generation as much as they can, including getting them on the property ladder. The key is to find the method that suits you all best, and to employ the best professional advice you can to ensure you do not fall into any hidden traps.
This article is taken from Private Wealth newsletter - May 2019