Personal Finance: Smart Alex seeks stability

Financial Makeover NAME: ALEX BARKER AGE: 26 OCCUPATION: FREELANCE JOURNALIST

Since graduating last June, Alex has had a number of short-term contracts, managing to find work most of the time. Although he has a mild disability, he is keen to be independent and would like to buy his own home.

Living in the Midlands, he can buy a flat suitable for his requirements for pounds 27,000 to pounds 30,000. With earnings of pounds 8,000 to pounds 10,000 per year, he could afford mortgage payments on such a property.

His parents, Florian and Brian, are keen to help out. Their thoughts were that perhaps they could buy a flat for him as a residential investment and then rent it out to him at an economic rent in lieu of the interest they would otherwise have received on the money used to buy the flat.

The adviser

Ray Boulger, technical manager at John Charcol, independent mortgage and financial advisers (0800 718191, www.johncharcol.co.uk).

The advice

The nature of Alex's earnings and the fact that he has only been working for a few months means it would not be feasible to obtain a mortgage with a good interest rate for him at the present time - assuming the mortgage was arranged in his name with no one else being involved.

Florian and Brian Barker want to help Alex but without putting the rest of the family at too much of a disadvantage, bearing in mind he is not their only child.

Using around pounds 30,000 of their capital to buy a house might have that effect. Because it would be treated as their second property, they would be liable to pay capital gains tax on any profits over pounds 6,800 made on the flat when it is sold. As they sometimes utilise all of their annual capital gains exemption this is a point not to be overlooked.

While the amounts involved are not huge, it would not be possible to claim Miras relief if the property was purchased as an investment.

The fact that Mr and Mrs Barker would be taxed on the rental income would merely put them in a similar position to the one they would have been in had they received interest.

An alternative approach would be to have the flat purchased in Alex's name with his parents acting as guarantors. Florian and Brian are ideally suited to do this as their own mortgage is now only pounds 6,000.

It would be sensible to limit Alex's mortgage to 90 per cent in order to avoid paying mortgage indemnity premium and providing that Alex does not have any significant breaks in employment, he should be able to afford paying the mortgage from his own income.

I would recommend that a mortgage should be taken out with the Halifax, partly because Halifax will consider guarantor mortgages up to 90 per cent in situations such as this, but also because the Barkers' own mortgage is with the Halifax.

Among the deals currently available, Halifax is offering a 1.45 per cent discount to the end of April 2001, an effective payment rate of 5.5 per cent. On a pounds 25,000 loan this means payments of pounds 149.61 for a repayment loan or pounds 107.25 on interest-only. There are no penalties and no arrangement fee.

Alternatively, Halifax is offering a rate of 5.35 per cent fixed to April 2004. Redemption penalties are on a six-year sliding scale, from 6 to 1 per cent. There is a pounds 295 booking fee. Monthly repayments on a repayment mortgage are pounds 147.58 or pounds 104.32 on interest only.

A key factor in determining which is more suitable will be whether the stability in payments offered by a fixed rate is important to Alex, bearing in mind that there will be redemption penalties within the fixed-rate term.

Halifax gives a cashback of pounds 250 towards the valuation fee and legal costs. As Alex's mortgage will be quite small, this is equivalent to a cashback of about 1 per cent.

One further benefit of arranging the mortgage in Alex's name is that he will obtain Miras relief. With a mortgage of around pounds 25,000 this will provide a worthwhile saving.

It is difficult to be precise about which type of mortgage repayment method would be the most appropriate. However, a repayment mortgage or a with-profits endowment mortgage would be the two options worth considering.

Whatever type of mortgage repayment method Alex decides on I would strongly recommend that he has life insurance and critical illness cover for the mortgage. In view of his mild physical disability it is likely that there would be some exclusions on a critical illness policy.

However, there should be no problem in getting cover for most of the conditions normally included, including the main risks of heart attack, stroke and cancer.

In the event that his disability had an impact on the premium for life insurance and critical illness cover it would have a much smaller impact on the premium for an endowment policy than it would for a straight term policy. This is just one factor which may be relevant in determining which repayment method is more appropriate for Alex.

Finally, there is the question of pension provision. Normally my advice would be that one should start making pension provisions as soon as is possible. However, Alex is still young and is hoping to get a permanent job in the near future, which could well be with a company which offers its own company pension scheme.

I would recommend that Alex defers making any pension contribution for the time being as, with his current income situation, it would seem inappropriate at this stage to start making contributions to a regular premium personal pension.