The Bank of Mum and Dad (or Gran and Grandad)
In these difficult times with lenders being less willing to give the high percentage mortgages they once did and the cost of property compared to salaries being so high first time buyers (and sometimes second and third buyers) are finding it more and more difficult to finance the purchase of a property.
As a consequence young buyers are, more and more, being assisted by their parents and grandparents in the purchase of that all important first property.
This is obviously good news as it allows the children to purchase a property which they may not have otherwise have been able to afford but can lead to unforeseen issues further down the line unless the basis on which the financial assistance is being given is made clear at the outset.
There are three common ways in which the funding can be dealt with all of which have advantages and disadvantages. The main ones are as follows (but it should be borne in mind that any financial assistance must be disclosed to the proposed mortgage lender):-
1. Gift – This is the simplest and most straightforward way to deal with the matter. The benefit is that there is no ongoing arrangement the monies are simply gifted. The disadvantages are that
(a) dependent upon the amount gifted and any other gifts you may have made during that financial year there may be a potential liability for Inheritance Tax should you die within 7 years
(b) once a gift has been made you have no right to demand the money is returned should you need it at some point in the future
(c) If the property is bought in the joint names of your child and his or her partner, and they subsequently separate, the partner may be entitled to a share in the value of the property which would include a share of your gift
2. Loan – a loan is made which can be subject to interest or interest free. This can provide you with the flexibility you need as you can agree specific terms for repayment eg monthly yearly or after a fixed period with or without interest. You can also vary the terms at any point although this should always be recorded in writing. You can also, if you wish, convert all or part of the loan to a gift at a later stage. Until you do, there is no possibility of your child’s partner being entitled to any part of the money. The potential disadvantages with a loan are:-
(a) The loan will have to be disclosed to the Lender, which may not allow any security over the property to be given for its repayment
(b) If you charge interest on the loan this will be classed as taxable income by HMRC and you will need to complete a Self Assessment Tax Return.
(c) If something were to happen to you whilst the loan was still running you would need consider whether it had to be repaid, continued or whether you wished to amend your Will to take the loan into consideration.
3. You acquire an Interest in the Property – Rather than lending or gifting the money you purchase a share in the property and become a joint owner. If you acquire a share in the property your investment will increase (and decrease) in line with the value of the property.
The potential pitfalls are:-
(a) Mortgage – If the property is being purchased with a mortgage you may be required to be a party to the mortgage, making you jointly liable to the Lender for the repayments –this can be overcome if your interest is dealt with by a declaration of trust
(b) Capital Gains Tax – Unless the property is your main residence (which is unlikely) any profit you make on your investment will be liable to tax subject to your annual exemptions
(c) Inheritance Tax – If you still own a share in the property at the time of your death this will form part of your estate and may therefore be subject to inheritance tax. You would need to make provision either in your will, the declaration of trust or both as to what will happen should you die ie do you leave the share in the property to your child or to your spouse, or into a trust.
As you will see from the above what at first appears to be simply trying to help out your children or grandchildren can lead to a whole raft of other issues which need to be considered before a decision is made as to the best way to proceed.
What route you take will be personal to you and will be tailored to your specific circumstances and requirements. It is therefore vital that you seek both the advice of your solicitor and accountant at an early stage to discuss the way to proceed in order to achieve the best and most cost effective solution.