The hidden risks of opening the bank of Mum and Dad

If you’re thinking of lending or gifting money to your offspring, wise up to the pitfalls first. 

Young property buyers have long relied on the so-called Bank of Mum and Dad to help with the costs of buying a first home. And why wouldn’t they? Parental loans typically have zero interest rates and don’t need to be paid back. 

According to Legal & General, the Bank of Mum and Dad is the equivalent of a £5.7bn mortgage lender, with 27% of buyers receiving help in 2018. 

But if you’re a parent thinking of lending or gifting money to help with your offspring’s house purchase, it’s wise to read on the pitfalls first. Personal Finance journalist Emma Lunn explains what to look out for.

Can you afford it?

According to L&G, about one in five over-55s helping their children on to the property ladder are accepting a lower standard of living for themselves to do so. One in 10 say they feel less financially secure as a result of helping out their kids. So, ask yourself, what would you do if you were made redundant or couldn’t work due to illness? Could you cope?

Things can take a turn for the worse – for everyone – if one or both parents are declared bankrupt in the future. The trustees tasked with liquidating your assets can pursue your children for any money given or lent to buy a home.

Is it a loan or a gift?

Most parents give their children a cash gift to bump up their deposit and boost their borrowing power so they can access a cheaper mortgage deal. Mortgage lenders usually want written confirmation that the money is a gift – they want to know that if they had to repossess the house, the parents don’t have a financial interest in the property.

Some mortgage lenders aren’t keen if you give your child a loan that needs to be paid back, and they will factor the amount into mortgage affordability calculations. 

Protecting your gift

If your child’s buying a property with their partner, and you’re gifting cash for the deposit, you can take steps to protect the money in the event of a split.

A deed or declaration of trust can set out what will happen in the event the relationship doesn’t last and the property is sold. This can be written to protect parental gifts so that your child’s ex-partner doesn’t waltz off into the sunset with half your hard-earned cash.

Be aware of the seven-year rule

You can give as much money as you want without incurring inheritance tax, provided you’re still alive seven years later. But if your estate is worth more than £325,000 and you die within seven years, your child may get landed with an inheritance tax bill. The figure rises to £450,000 (in 2018/19) if you leave the family home to your children, and will be £500,000 by 2020.

Obviously, no one knows when they will pass away but if your estate could be liable for inheritance tax, it’s worth taking tax advice sooner rather than later.

Offering security rather than cash

Some mortgage lenders offer products that allow parents to offer a chunk of equity in their own home, or a set amount of savings, as security for their offspring’s home loan. While these can be good options if you can’t afford to give your child cash, they’re not risk-free. If your child falls into mortgage arrears, their mortgage lender could come after you for the money. 

The same goes for guarantor mortgages: if your child falls behind on mortgage repayments, you’ll be liable for the debt.

Buying a property with your child

If you’re still working, you might consider taking out a joint mortgage with your child. But, if you already own a property, this will have stamp duty implications. The property you buy with your child would be counted as a second home, and you’d be liable for the 3% Stamp Duty surcharge levied on second home owners. There may also be a Capital Gains Tax liability when the property is sold later on.

'The hidden risks of opening the bank of Mum and Dad' is an article from Crowdstacker's new, free quarterly financial lifestyle magazine 'Fixed'. Read more insightful articles about personal finance, travel, technology, money saving tips and more by subscribing to Fixed magazine here.