The mortgage gift your kids won't thank you for
An inter-generational home loan seems cheap initially, but will cost in the long-term, warns James Daley
Saturday 26 August 2006
Kent Reliance Building Society may be tiny, but its big new idea is generating huge interest from borrowers and mortgage advisers. The UK's first inter-generational mortgage is a home loan that can be passed on from parents to children.
The initiative is aimed at both younger borrowers keen to get a foot on the increasingly unaffordable housing ladder, and older borrowers who want to maximise their disposable income. And there's even the prospect of a smaller inheritance tax bill for some families.
There are two parts to the deal. The first is that Kent Reliance's mortgage is an interest-only loan. Borrowers make no capital repayments at all - each month they just service the mortgage interest - cutting the cost of repayments.
Second, while most mortgages are set up on a 25 or 30-year term - by the end of which all the capital borrowed must be repaid - Kent Reliance will allow borrowers to take out loans over a much longer period. It has no set maximum, so the term could be 40 or even 60 years and if borrowers die before the loan is repaid, the whole deal can be passed on to their children.
Although Kent Reliance will review these mortgages every five years, borrowers will be able to hold on to the loans well into retirement as long as they can prove they have the ability to keep on meeting the monthly repayments.
Such loans are already commonplace in Japan, where inter-generational mortgages enabled buyers facing runaway house prices to borrow over periods of up to 100 years. Loans were passed on to children and even grandchildren if they had not been repaid on death.
"This is about giving people options - not telling them how to live their lives, not telling them that they can only have a 25-year mortgage which has to be paid off at the end of the term," says Mike Lazenby, the chief executive of Kent Reliance.
"It's worked in Switzerland and Japan, but in this country we do tend to think in straight lines - I think a bit of innovation should be encouraged."
Lazenby thinks the deal will appeal to several types of borrowers. Younger first-time borrowers would find monthly mortgage repayments more affordable, he says, while older borrowers may be keen to make the most of their income, and to keep repayments down to the minimum level possible.
The inheritance tax benefit is also attractive, the society believes. If you're left a house worth more than the annual threshold - £285,000 this year - there is 40 per cent tax to pay on its value. But the outstanding mortgage on the property comes off its value pound for pound, reducing or eliminating the tax bill.
Even without the tax benefit, there are savings to make. The monthly repayments on a £200,000 25-year Kent Reliance capital repayment mortgage - fixed at 5.15 per cent for five years - would be around £1,200, for example. On an interest-only basis, however, borrowers would pay around £350 a month less.
Even so, mortgage experts are highly sceptical. James Cotton, of independent mortgage broker London & Country, says: "If you have an interest-only mortgage for 60 years, the total repayments that you'll make to the mortgage company are likely to be much more than your children would have paid in inheritance tax."
Melanie Bien, of Savills Private Finance, another adviser, says that while a typical 25-year £200,000 repayment mortgage would cost around £350,000 (and leave you owning the entire property), borrowers would pay £400,000 on an interest-only mortgage over 40 years, and still own none of the equity.
Mike Warburton, of accountants Grant Thornton, adds that the benefits in terms of inheritance tax mitigation have also been overplayed. Although the IHT liability will indeed be smaller on a property with a mortgage, homeowners can achieve the same outcome by using equity-release products to unlock capital from their home.
Finally, Ray Boulger of mortgage broker John Charcol, says the burden of paying a mortgage in retirement should not be taken lightly. "If someone has got to the stage where they are taking out an interest-only mortgage because it is all they can afford, they should remember that they're even less likely to be able to afford it in retirement," he says.
As for the international success of inter-generational mortgages, there are doubts here too. In Japan, after thousands of homeowners had signed up to 100-year mortgages, the market eventually collapsed, leaving many borrowers sitting on loans which were much greater than the value of their property.
Keith Tondeur, the chief executive of Credit Action, the debt charity, says: "With debt in the UK causing problems for a record number of people and the 'buy now, worry about it later' culture in the ascendancy, people need to be aware that interest-only mortgages are high risk, particularly in a time of rising interest rates."
Tondeur also points out that lenders have most to gain. "Affordable housing is a very pressing need in the UK currently as many younger people struggle to afford property," he says. "Encouraging people to take on expensive debt may be popular with institutions such as Kent Reliance, which stand to profit healthily, [but] it is not the best solution."
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