From time to time, we are asked to share our expertise in professional and industry publications. Recently, Mark Penston was asked to co-author an article for the Family Law Journal concerning the financial and legal implications of opening the doors to the Bank of Mum and Dad.
With the Bank of Mum and Dad now the size of the UK’s 10th biggest lender, Mark teamed up with Graeme Fraser of OGR Stock Denton to write this timely piece about the implications for parents looking to lend or gift money to children.
You can read the full article in the Family Law Journal, but we have summarised the main points of Mark and Graeme’s article here.
Parents and the Bank of Mum and Dad
The scarcity of homes and the rapid increase in market values for properties mean that new entrants to homeowning must frequently rely on family members for financial support.
The so-called ‘Bank of Mum and Dad’ has developed in significance to the point that it is now equivalent in size to the UK’s 10th largest mortgage lender, with total lending having reached £6.3 billion.
If you have clients that are considering gifting money to their children or grandchildren, then it’s important that they consider the following:
- Is gifting funds prudent in the long term, or could it mean they run out of money later in retirement?
- What is the best way of providing the gift?
- Have they taken legal advice and put robust legal agreements in place?
In this guide, we’ll look at these three factors and what clients should consider if they are considering opening the doors to the Bank of Mum and Dad.
What size of gift is required?
A good place to start is to consider what affordability the children have in their own right and considering their own resources. If nothing else, this might add value to what the parents are proposing to do in supporting them. It also aids in understanding the magnitude of assistance that is needed in order to be able to purchase the desired property.
Consider how much the child has saved themselves, and what mortgage the child can secure based on their income. This will give the parent an idea of the size of the gift that is needed to support the purchase.
For example, if a client’s daughter wants to buy a £500,000 flat, has £30,000 saved as a deposit and her income is enough to get her a mortgage of £350,000, she is £120,000 short of the £500,000 she needs to buy the property.
It should be remembered that assessing mortgage capacity is a more complicated exercise than it perhaps used to be. Lenders now look at what they perceive to be ‘affordable’ to the borrowers and will use algorithms that focus on deposit available, income and expenditure.
What is the benefit of the gift provided by the parents?
There are two main benefits that a parental gift offers to a child:
- It helps a child to demonstrate that the mortgage is affordable: a deposit will reduce the size and cost of the mortgage and make a lender more comfortable lending money
- The gift creates a larger deposit that will allow access to a wider range of mortgage products and better interest rates. Typically, better interest rates will begin with a deposit of 10%.
Can the parent afford to make the gift?
In our experience, a key point that is often not sufficiently explored is: can the parents afford to make the gift? This matter could be brought into even sharper focus if the parents plan to separate or divorce.
What may appear to be a comfortable position now, may look completely different deeper into retirement. We have found that many clients find it difficult to project finances into the future without professional guidance and cash flow modelling.
Speaking to a financial planner can help a parent to understand whether a gift they are proposing is affordable.
Using Mum and Dad’s income to assist with the mortgage
In many cases, there may simply be insufficient resources available for parents to provide the financial support that their child needs. This may be particularly true for parents who want to offer equal support to multiple children.
One compromise that some clients consider is a mortgage option that allows the parents to go on the mortgage application for each respective child, but not on the mortgage deeds.
This allows retirement income to be taken into consideration to boost borrowing capacity. It also avoids the 3% Stamp Duty which would be otherwise applicable on second property purchases.
This may be used in addition to a gifted deposit.
The importance of robust legal agreements
Wealth protection for families is often far better achieved by putting into place agreements in advance of gifts being made.
In recent years, there has been improved awareness about the usefulness of cohabitation agreements and declarations of trust for those living together outside of the formalities of marriage and civil partnership.
For those who intend to marry, pre-nuptial agreements are increasingly used to protect family wealth brought into the marriage and to preserve the couple’s autonomy.
Declaration of trust and cohabitation agreement
As a pre-condition of advancing the monies, parents can insist that their child enter into a declaration of trust with their partner so that the amount they have contributed is returned to the child in the event that the couple split up.
An express declaration of trust will normally be determinative of the couple’s interests in their new home. The declaration of trust could also contain a formula in the event that either of the couple wishes to sell their interest, including the option to buy out the other in the event that the property is not placed on the market for sale.
A cohabitation agreement will enable the couple to record their rights and responsibilities in relation to the property where they live and financial arrangements between them during and after their cohabitation, and the arrangements to be made if they separate.
The agreement can allow for flexibility in terms of any investment being reflected in the ownership of a replacement or additional home in the event that they subsequently decide to move home, bearing in mind that the property may be a starter home and a larger property may well be needed later on.
In England and Wales, pre-nuptial agreements are not strictly binding in the event of a later divorce, but the terms may be decisive unless the effect of the agreement would be unfair.
To improve the prospect of the agreement being considered fair, the couple will need to set out their financial circumstances in full and take independent legal advice on the agreement and its effects. It is good practice to enter into the agreement in good time before the wedding, ideally a minimum of 21 days before the ceremony so that neither party feel undue pressure to agree to anything.
The agreement is more likely to be upheld if the terms are substantially fair, in providing for each individual’s basic needs in the event of their divorce.
The benefit to a child in entering into a pre-nuptial agreement is that they can protect their parent’s gift from their partner by classifying it as non-matrimonial property as opposed to matrimonial property.
Most pre-nuptial agreements require that non-matrimonial property belongs to the party who brought wealth into the marriage, although the extent to which this is possible depends on the length of the marriage and the other party’s reasonable needs.
To avoid future disputes, it is crucial that there is a clear documentary trail to confirm an agreement and any transaction involving gifts or loans to children should be carefully recorded.
Get in touch
Don’t forget that you can read Mark and Graeme’s full article in the Family Law Journal.
If you have clients who are considering gifting money to their children, it can pay to take both legal and financial advice. We can help. Email email@example.com or call us on 0118 987 6655.