How to repay the bank of mum and dad
At the same time, stagnant wages, rising unemployment and difficulty securing a loan from formal lenders is forcing many consumers to seek assistance from the bank of mum and dad when purchasing big ticket items.
These two trends mean an increasing number of Britons are indebted to their parents, and while parental loans may not incur interest, most will need to be repaid at some point. What are the best ways to do so?
If you are a parent lending to a child, there are a number of reasons you may be concerned about getting the money back.
For one, parents should consider how the ownership of the property will be structured between the child and their significant other, and how this would play out should their child die while the money is still tied up in the property.
“Property can be jointly owned in one of two ways: as joint tenants, which means if one owner dies the other is left owning the property outright, and as tenants in common, which ensures the deceased person’s share of the house passes in accordance with their will,” says Duncan Watson, solicitor at Stowe Family Law.
“Parents contributing to a property purchase for a child and their partner must ensure legal advice is taken to ensure the funds are protected and able to pass back to the parent should the child die before the parent.”
You may wish to put the loan in writing, in the form of a loan agreement. An agreement can set out the repayment terms, and any interest payable. Watson notes HMRC are often suspicious of loans from parents to children. It is thus essential a loan is documented if it is not to be treated as a gift and thereby avoid an assessment for IHT.
Judith Fitton, a partner in the family department of law firm Mundays, believes an agreement is important in the event your child’s partner decides to make a claim on the money at a later stage.
If your child splits up with their partner after borrowing the money, a loan agreement will help clarify matters and make it clear it was always intended the money would be repaid, and the money is not a joint asset.
“It’s an awkward subject for a parent to broach with their child as they don’t want their child to feel that they do not trust their partner,” she says.
“However, it is better to be upfront and agree full terms before making the loan rather than taking a risk and hoping it will all work out fine.”
For parents reluctant to broach the subject, Watson reminds both parents have a right to claim a share of the house in the event of a divorce, regardless of how the deposit was paid for.
“If one spouse’s parents contributed what may be tens of thousands they may be very concerned by the idea of some of that equity going elsewhere,” he says.
Alternatively, if a couple is married, the loan can be noted in a Pre- or Post-Nuptial Agreement. These documents set out how various assets, such as the house and finances, will be divided if the couple divorce and can ensure claims cannot be made on a parental loan.
If a couple is not married, Fitton suggests securing a Deed of Trust or Cohabitation Agreement, which sets out shared interests in their home and makes it clear the parent’s money has to be repaid.
However Watson notes these agreements are not legally binding as yet, despite repeated recommendations from the Law Commission to make them so.
“Judges will use them as a guide when they divide a couple’s assets but they are under no obligation to make a ruling in line with the terms of the agreement,” he says.
“But, they can inform a judge’s decision, and if done properly they can be very persuasive to a court indeed.”
Writing off the loan
The beneficent bank of mum and dad could alternatively choose to write off the loan in whole or in part. Beyond being an extremely kind thing to do, this may be a wise move for tax purposes.
After all, should a ‘borrower’ repay the loan and their parents pass away, they may end up paying inheritance tax (IHT) on the money they have given back if and when they inherit their parents’ estate.
If parents or children are worried about this eventuality, Julie Jaggin, senior associate in the private wealth department of law firm Mundays, notes the loan can be updated to a gift.
“It is important to record this by way of an appropriate Deed of Waiver as this has the effect of confirming when the gift was made,” she says.
“Any gifts made within seven years are counted within a person’s taxable estate for Inheritance Tax and so the importance of good record-keeping is vital.”
If a parent’s estate is valued at over £325,000, it is liable for IHT. The value of a gift will be taxed on a sliding scale, and possibly not at the full 40% rate.
Parents taking this route should update their Will accordingly, to ensure it accurately reflects this decision, and any lifetime gifts are taken into account in accordance with their wishes.
An alternative to writing off the loan could be for parents to ask for the loan to be repaid in the form of care costs, should they arise.
Watson notes parents taking this route should look to pass money to children well in advance of them needing full-time care, as making gifts close to that point are likely to be frowned upon by local authorities who are asked to foot a care bill.