The “Bank of Mum and Dad” has become a common source of funding for children buying their first homes in the UK. However, this informal arrangement can lead to legal and financial complexities. We outline key considerations for parents and children involved in such arrangements and are experienced in advising clients on navigating the legal issues which can arise.
The most common scenario for gifting money to children is to assist them with buying their first property by paying or contributing to the deposit.
The main issue with this is that most mortgage lenders will only accept a typical 10% deposit paid by a 3rd party if it is fully gifted (the position may differ if the amount advanced is larger than 10%). This potentially puts the money gifted by the parents at risk.
Alternatives to gifting money which may create a better degree of control but which also have potential drawbacks include guarantor mortgages, joint mortgages where the parents are also owners and/or offset mortgages.
How we can help
- Drafting legal documents – we can prepare essential documents like gift deeds, loan agreements, and trust deeds.
- Tax advice – we offer guidance on tax implications and strategies to minimise liabilities.
- Negotiating terms – we are experienced in negotiating terms for gifts, loans or trusts.
- Resolving disputes – if conflicts arise, lawyers can help mediate or represent clients in legal proceedings.
Tax Implications
- Capital Gains Tax (CGT) – if parents sell assets to fund the gift or loan, CGT may be applicable. Careful planning can minimize these tax liabilities.
- Inheritance Tax (IHT) – gifting large sums may have implications for IHT, being classed as a Potentially Exempt Transfer (“PET”). Consider using exemptions and reliefs to reduce potential tax burdens.
- Pre-owned asset tax – may arise if a parent moves in with child who used gifted funds to buy a property they now both live in.
Potential risks and Considerations with gifting large sums to children
- Relationship breakdown – family disputes can arise if the arrangement is not clearly defined.
- Financial hardship – parents may face financial difficulties if they overextend themselves.
- Property rights – if parents contribute to the purchase of a property, they may have ownership rights.
- Mortgage repayment difficulties – if the child struggles to repay the mortgage, parents may be at risk of losing their investment.
Safeguarding Advances to Children for Property Purchases
When parents advance money to their children for a property purchase, especially one involving co-owners, many of our clients want to take steps to safeguard the funds. Here are some strategies:
- Clearly define the relationship – is it a loan or gift? This affects tax implications and potential rights. Decide if the parents will be joint owners or if the child will own the property outright.
- Formalise the arrangement – If it’s a loan, create a formal loan agreement outlining terms like interest rates, repayment schedules, and security. If it’s a gift, a gift deed can document the transaction and avoid misunderstandings. For larger sums, a trust deed can provide more control over the funds and protect the interests of all parties.
- Notify any mortgage lender – Obtain the mortgage lender’s consent for any additional funds being invested in the property, otherwise both the borrowers and you may be found to have misled the lender. The mortgage lender may also consent to a 2nd charge being registered by you.
- Become joint Owner – ensure your name is on the property title. The lender may require you to be a party to and liable for the mortgage if you’re a joint owner.
- Right of first refusal – consider negotiating a right of first refusal if the child wants to sell the property.
- Repayment guarantee – If the child is struggling to repay a loan, you may want to require a guarantee from their partner or other co-owners.
Potential Problems with Mortgage Lenders
- Loan-to-Value Ratio – if the parental advance significantly increases the loan-to-value ratio, the lender may impose stricter terms or require additional security.
- Affordability Assessment – the lender may re-assess the child’s affordability based on the additional income from the parental advance.
Tenancy agreement needed?
A tenancy agreement is particularly useful in situations where parents are loaning or gifting money to a child and their partner to purchase a property.
Here are some scenarios where it can be beneficial:
- Joint ownership – if the parents and the child’s partner are joint owners of the property, a tenancy agreement can establish the terms of occupancy, including rent, utility payments, and maintenance responsibilities. This can help prevent misunderstandings and disputes.
- Loan repayment – if the parents have loaned the child money, a tenancy agreement can stipulate that the rent paid by the child and their partner will go towards repaying the loan. This can provide a clear repayment schedule and help ensure that the parents’ investment is protected.
- Dispute resolution – in case of disagreements between the parents and the child’s partner, a tenancy agreement can provide a framework for resolving disputes and avoiding legal complications.
Example Scenarios of ways we can assist
- Deed of gift – where parents gift funds towards their child’s property purchase. A gift deed is drafted to formalise the transaction.
- Parental loan – loan agreement outlines interest rates, repayment terms, and potential security.
- Trust deed – with larger sums of money, parents might establish a trust to manage the funds, with the child as the beneficiary. A trust deed would outline the terms of the arrangement.
- Parental wills – can be drafted to ensure equity between their children by making equal gifts or deducting the existing gift.
