Opening a branch of the Bank of Mum & Dad
The Bank of Mum and Dad has been increasingly in demand in recent times. Parents are predicted to lend more than £6.5bn this year to help their children get on the property ladder, and the ‘bank’ is unofficially the 9th biggest lender according to the Financial Times.
New research from Royal London highlights the hidden costs of opening a ‘branch’.
How did we get to a stage where young people cannot afford to buy a home and get on the property ladder?
House prices are going up but the wages are not increasing at the same pace, resulting in first time buyers unable to get on the property ladder.
The increase in demand of the Bank of Mum and Dad is reflective of our broken housing market. Children are turning to parents to either gift or loan money towards a deposit, the entire purchase price, or simply to become a guarantor for the mortgage.
This is an example of intergenerational inequality; young people today don’t have the same opportunities that the baby boomers had such as affordable housing, defined benefit pensions and free university education. I know baby boomers didn’t have it easy, but in this case there isn’t parity.
Parents want to help their children who are struggling as best as they can, but may not consider the hidden costs.
Royal London have highlighted four things to consider before opening a branch of the Bank of Mum and Dad. These considerations include taxation, future financial hardship of parent or child, the impact of falling house prices, and changes in the relationship status of the child.
Taxation: If the parents are named on the deed of the house, the house would count as a second home and would be obligated to pay a higher rate of stamp duty. If they sold the property on, they would be liable to a capital gains tax bill if the property increased in value. Lastly, if the parents died within seven years of “gifting” the money they would have to pay an inheritance tax on the gift as it would count as a part of their estate.
By being generous and incredibly helpful you can implicate yourself, especially paying a higher stamp duty, which is 3% more. For older parents, gifting the money can be an issue with inheritance tax, unless you survive seven years.
Future financial hardship of the parent or child: Parents might hand over what is, at the time, an affordable amount to give. In the future the financial circumstances of the parents might change, which they very easily can, you can’t get the money back straight away. If you tried to get the money back it would involve evicting your children which parents would prefer not to do.
Secondly, if the child has committed to paying the mortgage, and a parent is either a guarantor or named on the deed, if the child can no longer meet the mortgage payments the parents have to foot the bill. Which is going to put a strain on the parent’s finances.
Impact of falling house prices: The reason first time buyers are struggling to get onto the property ladder is because housing prices have been going up since 2009. Unfortunately they might not continue to rise as they have in the past; at some point they could fall in value, and if the property needed to be sold after a housing market cash, the house might be in negative equity. This would result in a loss on capital and where the initial purchase would have been an investment there will not be a positive return.
Changes in the relationship status of the child: If the parent makes a gift and then the child forms a new relationship or existing relationship breaks down there could be a dispute about the money and the ownership of the house. In a marriage the assets are equally owned, so if some money came from the parents the money could be lost in the event of a divorce.
Clarity at the beginning in crucial. You need to establish whether the money is a gift or loan. A written agreement about financing of the home is the safest bet.
If the money is a loan however, the child may experience difficulties getting a mortgage if there are regular loan repayments to make to parents.
In today’s society it is sensible and realistic to have pre-nuptial agreements in place. Once money is involved in a relationship you have to be practical. Unfortunately discussing breakups at the beginning of a relationship isn’t always ideal but it is sensible.
There are various ways parents can help their children, should they decide to open a branch of the Bank of Mum and Dad:
• Acting as guarantors: Parents can use the equity on their own home, or place money on deposit with the lender to provide a guarantee that mortgage payments will be maintained. This is a good idea if you know your child is able to maintain mortgage payments.
• Raising mortgage on own home: If you re-mortgage your house in order to help your children there is a risk using debt to buy a second home.
• Providing funds to open lifetime ISA for your children: allows you to deposit money without tax implications with the added benefit from a government top up for first time buyers.
It’s important to speak to an Independent Financial Planner before making a gift or a loan to your adult children, to carefully consider the risks described in this article and understand how it will factor into your own Financial Plan.