Hidden costs of opening Bank of Mum and Dad

The insurer’s new guide, ‘The Bank of Mum and Dad – Five things to consider before opening a branch’, highlights a range of issues which parents need to consider and some of the pitfalls that they need to be aware of.

These include:

–       Taxation: If parents are named on the deeds to a property purchased with a child they could be liable for the higher rate of stamp duty which applies to the purchase of second homes. They could also find themselves with a capital gains tax bill should the property be sold at a profit at a later date. Conversely, gifts towards a deposit can still count towards a parent’s estate for inheritance tax purposes if they die within seven years of giving the money;

–       Future financial hardship of parent or child: Parents can hand over what they believe is an affordable amount only to find their own circumstances change due to redundancy or ill health and they find themselves short of money. Similarly, children may initially be able to make repayments of a loan to parents only to find that it becomes a struggle once they have children or face unemployment or sickness absence;

–       Impact of falling house prices: Even after several years of strong house price growth parents must consider their position in the event of the property needing to be sold after a housing market crash. If the property is in negative equity then parents may not see their money returned when they expected.

–       Changes in the relationship status of the child: Parents will want to help their own children but may want to think what would happen if their child forms a new relationship or an existing relationship breaks down – could there be a dispute about how much of the house is owned by each party?

The guide stresses the importance of clarity at the start of the arrangement as to whether help is a gift or a loan, and also suggests that the young homebuyer could consider a written agreement with their partner about the financing of the home.

In addition to a gift or a loan towards a house deposit, the guide also highlights a wide range of different ways in which parents may wish to help their sons or daughters with funding for a new home including:

–       Parents acting as guarantors on the mortgage using the equity on their own home, or placing money on deposit with the lender to provide a guarantee that mortgage payments will be kept up;

–       Parents raising funds on their own home through a second mortgage or equity release;

–       Parents providing funds for their son or daughter to open a Lifetime ISA, benefiting from a government top-up of 25%;

Given the range of ways in which parents can help their children, Royal London strongly encourages parents to take impartial financial advice before deciding how best to help.

Helen Morrissey, personal finance specialist at Royal London said: “Steep house price rises in recent years have made it difficult for younger people to get on the housing ladder and it is understandable that parents want to help. However, making the decision to hand over a large sum of money, whether as a loan or a gift is a major financial commitment and parents need to consider all the options before deciding to do this. Parents must ensure they are aware of the potential tax implications and consider giving away or lending a large sum could affect them further down the line if their circumstances change.

“In addition, arguments over whether money needs to be repaid, or over what time period, have the potential to cause considerable harm to the parent/ child relationship. It may seem very formal but all parties should consider taking legal or financial advice and if needs be get something down in writing. Taking this approach can bring much needed clarity to the process and save both parties a lot of grief.”