Bank of Mum and Dad, helping a child who also will have a commercial mortgage

In the latest of our “Bank of Mum and Dad” series, our experts take a look at issues arising where parents help a child buy a property when the child is using a bank or building society mortgage.  Stamp duty land tax, income tax, capital gains tax and inheritance tax issues are considered for various structures.

Den and Karen are Richard’s parents and own their own home. Richard left home five years ago and has been renting a property near his work.  He is aged 25 and has been looking to buy his first home for about £300,000.  He has a 5% deposit and is finding his mortgage options limited; he could obtain a more competitive mortgage if he had more equity.  Richard is single, will be buying alone and is a first time buyer.

Den and Karen have looked at various ways of helping Richard as outlined below.  They can raise £30,000 in cash which they are prepared to make available one way or another.  They would not object to guaranteeing Richard’s mortgage in some way.  They do not have the means to provide enough funding to dispense with Richard’s need for a mortgage, but hope that with their help, Richard will be able to obtain a mortgage on more favourable terms.

Options for helping their son

• 1) Den and Karen come in with Richard as joint buyers 

Den and Karen could use their £30,000 to buy a 10% share of the property, with Richard owning the other 90%.  This would reduce the proportion of the £300,000 price Richard needs to borrow from 95% to 85%.  It might not be easy for Richard to find a lender who would be happy to lend to him when his parents have a share in the property.  Lenders who would countenance this structure would usually require Den and Karen to be liable on the mortgage as joint borrowers and so liable for the whole of the loan.

This structure would leave Den and Karen’s money invested in a property which might increase or decrease in value.  The three of them should set out the agreed terms of the joint ownership in a declaration of trust, which would cover such things as who is to occupy, pay the mortgage, meet outgoings including insurance, and who is to deal with and pay for repairs.  It should also cover whether Richard has to pay an “occupation rent” (a notional rent to reflect the fact that Den and Karen have a 10% share but are not to occupy).  The entry of an appropriate “restriction” on the Land Registry title should sometimes be made to serve as a reminder of the existence of the declaration of trust.

• 2) Den and Karen could lend Richard money 

Den and Karen could lend the £30,000 to Richard so that he becomes the sole owner of the property.  However most mortgage providers (since the Mortgage Market Review in 2014) would not be prepared to proceed on this basis.

Some lenders would allow this structure (subject to being satisfied as to affordability) and would allow Den and Karen to have a second charge on the property behind that of the mortgage provider, so long as a deed of priority is signed to make it clear that the proceeds of sale of the property would be used first to clear the indebtedness to the mortgage provider.  A written agreement would be needed as to the terms of the loan from Den and Karen, including whether interest is payable and when the loan is repayable.

• 3) Den and Karen gift Richard the money 

Den and Karen could give Richard the £30,000.  The lender will require them to sign a form to confirm that it is an outright gift and they do not expect repayment, nor have any equity or legal interest in the property.  The property would belong entirely to Richard, subject to the mortgage from the lender.

• 4) Den and Karen could become parties to the mortgage  

It used to be relatively common for lenders to offer mortgages where the parents would guarantee their child’s payment of the debt, often giving a charge on their own home as collateral.  These have become much less common.

Many lenders now offer “Joint Borrower Sole Proprietor” mortgages.  This would enable Richard alone to own the property, but for Den and Karen to be liable for the mortgage debt jointly with Richard.  Den and Karen could be called upon to pay the whole loan.

• 5) Den and Karen could put money into a bank account as a family offset mortgage

There are mortgages available where relatives, such as parents, deposit money in a bank account with the lender who is to make the mortgage advance.  This would enable Richard to be the sole owner of the property.  These products typically enable borrowing at a higher loan to value proportion such as 95%.

The money in the account often earns interest, but the money is available to the Bank should mortgage payments be missed. The money is usually committed for a set period, or until a certain percentage of the loan is paid off; typically so that the loan to value ratio is reduced to 70% – 75%.

With some products no interest is paid on the sums in the bank account, but the interest the child pays is reduced, being calculated on an offset basis.

Tax analysis

The SDLT analysis has been provided by John Shallcross; the income tax, capital gains tax and inheritance tax analysis by private client specialist Paula Shea.

• A) Stamp duty land tax 

SDLT is calculated on slice rates, with each slice of the price bearing tax at the relevant rate, with the rates on the higher slices increasing.  A purchase for £300,000 is liable to SDLT at different rates depending on the type of purchase:

• £14,000 if the higher rates of SDLT for additional property apply
• £5,000 if standard rates of SDLT apply
• Zero if first time buyers’ relief applies.

If Richard alone buys the property he might well qualify for first time buyers’ relief (see scenarios 2 – 5).  There is an article about first time buyers’ relief here. Note that in scenario 4 Den and Karen are liable on the mortgage, but have no share in the underlying ownership of the property; so Richard remains the only buyer for SDLT purposes.

If Den and Karen take any share in the property at all (even if bought “in the name” of Richard) the higher rates of SDLT will be due on the whole of the purchase price because they own their own home (see scenario 1, the only one of the scenarios where they take a share in the property).

• B) Income Tax 

If Den and Karen lend Richard the money interest free they are not treated as receiving income.  If they charge Richard interest, it should be paid to them gross (Richard does not make a deduction for tax) but Den and Karen need to account for the income on their tax returns on the basis of sums received.  They will pay income tax at their marginal tax rates if their income exceeds their personal allowance.  The rates are currently 20% for basic rate taxpayers, 40% for higher rate tax payers and 45% if the additional rate applies.  There is presently a personal savings allowance, meaning that every basic rate taxpayer can earn £1,000 interest a year without paying tax on it (higher rate payers get a £500 allowance, and additional rate taxpayers do not get an allowance).

There are no income tax implications for Den and Karen if they gift Richard the money.

If Den and Karen take a share in the property then there is only an income tax implication if they receive income from it, such as an “occupation rent” if Richard pays that to them or, if the property is let out, their share of the rent less deductible expenses.  The income would be liable to tax at their marginal tax rates of 20%, 40% or 45% if their income is over their personal allowance.

Interest received from the bank account in an offset mortgage would be credited by the bank gross (without deduction of tax at source); Den and Karen would be liable to income tax in the same way as on interest received from Richard, as described above.

• C) Capital Gains Tax 

Capital gains tax (CGT) becomes an issue when the property is sold.  The rules might well have changed by then; the 2018 Autumn Budget announced some proposed changes.  On the basis of present rules though what could be expected if a gain is made on a sale is as follows.

If Den and Karen have a share in the property then they can each expect to pay CGT on any gain on their share after any unused personal CGT allowance for the year (currently £12,000) at 18% and 28% (18% to the extent that if added to their income it would be taxed at the basic rate).

Richard would expect to benefit from private residence relief.  This depends on him having lived in the property as his only or main residence.

• D) Inheritance Tax 

If Den and Karen buy a share in the property themselves then any increase in its value will form part of their estate.

If Den and Karen lend Richard the money then any increase in the value of the property will be outside their estates, but the value of the debt owed to them by Richard will remain part of their estates.

If Den and Karen give the money to Richard and they do not “reserve any benefit” from the money, i.e. provided they do not continue to derive any benefit, then after seven years the value of the gift should fall out of their estates.

Practical matters

Practical factors are likely to be more important than tax for Den, Karen and Richard and include the following:

• The availability of mortgage finance on good terms on the various structures; they will need a good mortgage broker to help with this.
• The ages of Den and Karen will be relevant to whether a lender is prepared to accept them as guarantors or joint borrowers (also their financial position and whether they are working).
• If they become responsible for the mortgage (as guarantors or joint borrowers), whilst they expect Richard to meet the payments, they would be liable for the whole of the borrowing and can expect the lender to enforce against them if Richard does not pay.
• Entering into a guarantee or joint mortgage is likely to affect their credit score and their ability to borrow, for example should they move home.
• Is it appropriate to be making a gift to Richard?  Might he make unwise decisions or even become bankrupt?
• Are they ready to give away money, or would they rather have a structure which means they retain their assets?
• Would Richard rather rely on his own resources?
• How well would the structure work should Richard wish to sell the property and buy another one?
• What would happen if Richard wants to spend significant sums on alterations (especially if the property is jointly owned)?
• Would the structure chosen have any impact should Richard marry or enter a civil partnership?
• Are there other children, so that issues about treating siblings fairly and / or equally need to be addressed?

Earlier articles in the Bank of Mum and Dad can be found here for the first one and here for the second one.

For professional advice on SDLT please contact Blake Morgan’s SDLT expert, John Shallcross.  For advice on income tax, capital gains tax or inheritance tax contact private client specialist Paula Shea.

This article is intended for general information purposes only and does not constitute legal or professional advice. Advice should be sought before proceeding with any transaction.

This article was originally posted by John Shallcross on 9 September 2019.