You can't always count on the Bank of Mum and Dad
First-time buyers need to be aware of potential problems involved in borrowing money from their parents for deposits. Michael Millar reports
Sunday 05 September 2010
While the Bank of England continues to prop up the economy, another equally venerable and long-suffering bank is helping to keep the housing market on its feet. It has more branches across Britain than any other bank and no shortage of customers wanting to make withdrawals. In fact, there's a good chance younger readers already have an account there: at the Bank of Mum and Dad.
When it comes to helping children buy their first home, the Bank of Mum and Dad has never been more needed. Figures from the Council of Mortgage Lenders show a record 84 per cent of first-time buyers under 30 turned to their parents for help with a deposit in the last three months of 2009.
Experts agree that the size of the deposit is the most important factor determining what mortgages will be on offer. Halifax figures show the average first-time buyer put down a deposit of £30,380 during the second quarter of the year, equivalent to 22 per cent of their home's value.
Lenders often operate in 5 per cent increments when assessing your deposit, says David Hollingworth from London & Country Mortgages.
"There are big differences in mortgage rates if you have 15, 20 or 25 per cent deposits," he says. "So if you have a 19 per cent deposit it might be worth having a look in the piggy bank because if you can get 20 per cent you might bring in other lenders with better rates."
Parents helping with the deposit have to ask themselves what form this will take. If you make a gift of cash, then the Treasury will keep a close eye on you. "For inheritance tax purposes, parents must survive the gift for seven years for it to fall outside of their estate for IHT," says Dennis Hall, managing director of Yellowtail financial planning. "However, each parent can make an annual gift of £3,000, and if the previous year's allowances have not been used, then these can be carried forward one year."
So together parents could give £12,000 a year to a child without any IHT implications.
With a larger gift, parents can be liable for income tax on any interest the money generates. This is to deter parents from using their children's bank accounts to avoid the tax.
Bringing the extended family on board doesn't arouse the same suspicions, however, says Adrian Lowcock, senior investment adviser at Bestinvest. "If you get grandparents or the like involved, anything they give over £3,000 will not be hit for income tax in the same way parents' gifts would," he says.
But many branches of the Bank of Mum and Dad will want a return on their investments and so prefer to lend money for a deposit rather than give it outright. This raises the thorny questions of repayment terms and whether a loan to a family member should be set in legal stone.
"One of our clients wanted to lend a large amount of money to help her son and his new wife to buy a property and we suggested using a solicitor to draw up the agreement, with a start date, end date, and repayment details," says Dennis Hall. "We even wanted it to be secured against the property but they felt that was a step too far. In our view it would have given her protection in case things became difficult in the future."
Ray Boulger, a senior technical manager at mortgage broker John Charcol, says most parents wouldn't lend if they didn't think they would get it back at some point, making a formal contract unnecessary. "The important exception is if the child is buying with his or her partner," he says. "If parents provide 'x' amount of money and the child splits from their partner, then a parent could lose part of the loan to the partner."
While boosting the deposit is the obvious way the Bank of Mum and Dad can help, there are alternatives.
Traditionally, parents could improve their offspring's mortgage prospects by offering to act as guarantors who would make the loan repayments should their children fail to do so. But in these austere times, this is increasingly a last resort.
"If the child can't borrow outright, then banks will be suspicious," says Adrian Lowcock. "This essentially marks you out as someone who can't afford the property."
If lenders do entertain the idea of a guarantor, they will want to be reassured that the child has strong earning potential within the next three years or so.
A few lenders are trying to ease this situation by letting parents guarantee just a slice of the mortgage payments. David Hollingworth points to the Mortgage Works (part of Nationwide Building Society) and Leeds Building Society as examples.
Co-ownership gives lenders the opportunity to take both parents' and offspring's income into account, meaning a bigger mortgage is on the cards.
But if parents own another home they will be liable for capital gains tax when the co-owned home is sold. (And don't think you can trick the wily taxman by selling your stake at a knock-down price to your offspring; it has to be at market rate).
No matter how sprightly the governors of the Bank of Mum and Dad might feel, there is a good chance they will be faced with age discrimination by mortgage lenders.
"A lot of lenders now have a maximum age on any mortgage of 75, no matter what proof you offer of guaranteed income in retirement," says David Hollingworth. "You might be 55 now, but that would probably stop you getting a 25-year mortgage."
This is a result of closer regulation and increased concerns about retirees finding themselves saddled with too much debt at a time when pension pots are under a lot of strain.
Finally, parents across the country will be pleased to hear some of the greatest help they can offer won't cost them a penny. "One of the best things parents can do is to give their children some advice before they go looking for a mortgage," says Mr Boulger. "Most lenders will check your credit score, and if you don't measure up you will exclude yourself from a lot of deals out there."
"Trivial misdemeanours can count against you, like a late credit card payment," he says. "Don't exceed your overdraft limit; don't have direct debits that don't go through, and make sure you are on the electoral register."
'I couldn't have done it without my parents'
Carlie Masters, 23, left, a teacher from West Sussex, and her boyfriend, John, 24, completed their purchase of a two-bed flat in Crawley last week.
But they would never have been able to buy it without her help of her parents (pictured) because they could not afford the 15 per cent deposit, which was more than £26,000. So Carlie's father, Duncan, stepped in to put down the money.
"My mortgage was coming to an end and we had equity in our house," said Duncan. "So I remortgaged and took £30,000 to cover Carlie and do some home improvements."
Carlie and her boyfriend will repay the loan to her parents in monthly instalments, but that won't cover her father's pay-ments to the bank, so he will make up the shortfall. Duncan hopes to pay off his loan in five years. Carlie and John will then spend another three years paying back the extra. "I would have liked to move out without help," said Carlie. "But everything is so expensive and it would have been impossible."
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