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First Time Home Buyer Guide

How Parents Can Help with a Deposit

With so many parents having to help their first time buyer children, it's useful to know how they can help provide the deposit.

Having at least five per cent to put down in capital, will open doors to more lenders and better deals - especially since the so-called 'credit crunch'. It will also provide a buffer zone should property prices fall and therefore help avoid the possibility of being in negative equity (i.e. owing more on your mortgage than the value of your property). With the average price of a UK home so high, a five per cent deposit currently amounts to a considerable amount. Whether your intention is for a parent to give or loan this money to a child, either for the deposit or to help with some of the costs, they will first need to raise it. Parents will invariably need to take inheritance tax planning advice if making a gift.

Unless the parent has oodles of savings, they will almost undoubtedly need to speak to an advisor to discuss options such as remortgaging, equity release or a get a quote for a secured loan if they are concerned about their credit history. The most common way of helping provide a deposit is simply by taking out an unsecured personal loan - particularly easy if the parent is still employed. It is a good idea to get a quote and see how affordable it is. These are the best first step to take.

There are a number of ways a parent can find the finances to help their grown up children with a deposit.
Scroll down to find out more about:

Taking out a Further Advance / Remortgaging
One way to help kids buy their first home is to take a ‘further advance' which means increasing your mortgage with your existing lender. An alternative is to remortgage with a new lender and you may wish to use the opportunity to obtain a better deal. Even if you have remortgaged or have taken a further advance in the past, house prices have gone up at such a rate it is likely you will still have equity to tap in to.  Your home may be at risk if you do not keep up payments on a loan secured against it.

Remortgaging accounts for over 40 per cent of all lending, so the process is more straightforward than ever. However, it may not be worth remortgaging if you are tied into your mortgage and will have to pay redemption penalties to leave. You will also need to consider any costs involved in remortgaging as opposed to taking a further advance. If for any reason you are no longer receiving an income, it is unlikely you will be able to get a remortgage but an equity release scheme (see below) may be suitable. 

Selling your endowment policy / policies
Remember: As endowments are designed to run their full term, they often involve reduced allocation rates in the early years and as such should be held for the full term in order to achieve maximum benefit. Early encashment will almost certainly mean an MVA will be applied and there will be a complete loss of any future participation in the life funds bonuses. There are potential implications surrounding income tax and loss of life cover involved in the early surrender or sale of a policy. The endowment is likely to be been used in conjunction with an existing mortgage and as such a suitable alternative would have to be arranged.

Whether or not your endowment policy is on target to pay off your mortgage, you still have the choice of surrendering or selling the policy to raise funds. Surrendering the policy (or cashing it back in with your life insurer) can incur penalties, meaning you get less than its true worth. But if you sell it on to an investor through firms such as the Association of Policy Market Makers (APMM) it could save you around 20 per cent.

Bear in mind you will not be able to sell your policy if it is less than seven years old or worth under £1,500. It will take around two to three weeks before the funds are in your account.


Equity release

This is a scheme that will theoretically deliver your child's inheritance early. The most popular type of equity release is a lifetime mortgage. This is when you take out a loan against a certain percentage of your property (up to 50 per cent depending on your age), which you can choose to receive as a lump sum.

The interest on the loan – which is usually fixed and at a higher rate than on a standard mortgage – accumulates over your lifetime. No repayments are due when you are alive. Instead the loan is repaid on your death after which time the house must be sold, typically within a year. All schemes regulated by industry body, SHIP (Safe Home Income Plans which can be found at http://www.ship-ltd.org/), carry a no negative equity guarantee i.e. you will never owe more than the value of your home.

However, even if you took a lifetime mortgage on just 25 per cent of your home, this still means that your beneficiaries could be left with nothing if you go on to live a long time. Variations to the above scheme are available which allow you to make regular interest only payments on the liability, thereby potentially negating the negative impact of compound interest accumulation.

The other form of equity release, home reversion plans, involve selling a proportion of your property to a finance provider, usually at a discount to the market value. Upon death or sale of the property the finance provider takes a proportionate sum representing their percentage share of the property. However, they are not as popular as lifetime mortgages due to current low interest rates. If considering a lifetime mortgage as a method of raising capital it is important to note that they are not appropriate for everyone and will not be suitable in all situations. Should you be contemplating equity release you should consider discussing it with potential estate beneficiaries and also check any impact on state benefit entitlement.

Selling/mortgaging some of your property to an equity release company and giving the money to your child/children
You could take a lifetime mortgage or home reversion plan - both equity release schemes explained above and give the proceeds to your children to help them buy a home. However, with a lifetime mortgage you would not be able to release the entire value of your home; 50% is the maximum. Although you can sell 100% of your home through a home reversion plan, you will typically have to be over 90 years old to qualify for this level. If you take a home reversion plan, depending on your age, you will only receive between 30 and 60% of the open market value of the proportion of the property you are selling.

With a lifetime mortgage, when the home is sold after you die, the equity release company will take back the same proportion as was mortgaged. This means your children losing considerable equity and if you live long enough, the compound interest on the loan could end up totalling 100% of the property value.

However, the cash lump sum will be received tax-free from the equity release company with either scheme and can initially be passed tax-free to your children. If you both die within seven years, the cash would become a 'gift with reservation' and would form part of the estate again when it comes to calculating IHT.

If you died after seven years, giving money to your children by using an equity release scheme would potentially reduce their IHT liability.

Using your savings
You could use your savings for your child's deposit but – depending on the type of account in which they are held – there could be repercussions. For example, some regular savings accounts only offer a preferred rate of interest or a bonus on the condition that a limited number of withdrawals – or none at all – are made within a given time frame.

Notice accounts can require anything from seven to 120 days' notice if you want to make a withdrawal without paying a penalty. Most notice periods however are between 30 and 60 days. Bonds or ‘Term' accounts do not often allow any withdrawals before the maturity date which is typically set between one and five years. If a withdrawal is permitted, it is likely to come with a heavy penalty.  

Getting cash out of your pension
If you have a personal pension fund you can take 25 per cent of it as a tax-free cash lump sum. Currently, the remaining 75 per cent must be used to buy an annuity and you have to be aged between 50 and 75 to withdraw cash from your fund regardless of whether you are retired or working.

It is important to note that accessing pension benefits prematurely is not suitable for most people and will reduce your retirement income. Any income received from a pension is taxable and may result in you paying a higher marginal rate of tax. Should you wish advice in this area you should consult a pension specialist.

Mortgaging an overseas property
If you have a property that you bought for cash overseas, it is possible to release some funds by taking a mortgage against it. You will not be able to raise funds with a UK bank or building society, as they will only lend on properties within the country.

However you may be able to take a loan from a local lender in the country of your overseas property and there are brokers at home such as Conti Financial Services Ltd that specialise in this process. Request an overseas mortgage consultation. If you are brining money back into the UK you will need a competitive currency exchange service.

If you feel more comfortable using a familiar lender, there are overseas divisions of some UK banks – Halifax operates in Spain for example under Banco Halifax Hispania – but they will still be governed by the same laws and regulations of the country in question.

Remortgaging your overseas home may cost between two and three per cent of the property, depending on the country, in notary and legal fees. The amount of mortgage you may be able to raise on a home abroad will typically amount to between 70 and 85 per cent of its valuation, although this will also depend on the country.

Giving them money
If you want to make a gift of a deposit to your child you are able to do so, at any amount, tax-free. However, under current Inheritance Tax laws, if the amount you give exceeds £3000 in any one year, you will have to live a further seven years for the excess amount to be completely discounted from your estate when you die. If you die within seven years, Inheritance Tax will be payable on the excess sum over £3000. Additionally, if you have not already done so, it is possible to utilise your previous tax years gifting allowance thereby gifting £6000 free from inheritance tax. 
 

Selling them your property
You could sell your main residence to your offspring while continuing to live there. There are no laws to state how little you can sell the property for so you could choose a price below market value at which your child would be able to qualify for a mortgage - £100,000 for example. If you have more than one child, they could take out a joint mortgage, or they could simply be joint owners.   However, you would have to pay the new owners (your child or children) a market rent if you continued to live in the house yourself. You cannot live there for nothing, or for a peppercorn rent, otherwise you risk falling foul of the pre-owned assets tax or POAT. This tax was introduced in April 2005 specifically to prevent families giving away assets from which they might derive benefit in future – such as, selling or giving your property to your offspring and then continuing to live in it for nothing. To find out a cost effective way of helping your children, take tax advice.  

If they take out a mortgage, as the lender valuation of the property will price it at market value, this arrangement means a low 'Loan to Value' and therefore your child/children would qualify for the best mortgage rates. But there will be tax implications. For example, if your property is worth £300,000 on the open market and you sold it to your children for £100,000, they would still have to pay stamp duty on the market worth. Selling at a knock-down price also means your estate is worth less, which constitutes an 'IHT avoidance device'. This means that if you both die within seven years of the sale, HMRC will still calculate IHT on the difference between the purchase price and current value of the estate. IHT is payable at 40% on estates worth over £300,000 (from April 2007). Ideally large 'gifts' should be made as long before death as is practically possible. On death, all properties must be independently valued for probate and there are rules in place to avoid deliberately low valuations. The best advice is: be very, very careful and we cannot stress too often: take IHT advice for this extremely complex and rapidly-changing area.

As your children will presumably not be living in the house with you after the sale, the property will be classed as not their primary residence, so will count as a capital gain and attract capital gains tax. This means that after you die and the property is sold, your children will be charged CGT on the increased value in real terms - this means the difference between what the property was bought for and what it is sold for. This will be a significant difference as not only was the purchase price low, the property may have risen in value. CGT currently applies at a rate of 40% although each child will have a personal tax exemption of £8,800 (tax year 06-07). In this case, it could be a better option to keep the property as a buy to let investment rather than selling. Independent advice should be sought from an Inheritance Tax Advisor.

Charging you rent on their new property
If the property belongs to your offspring, they may need to charge you rent to help with the mortgage repayments; to comply with current tax laws, they must charge you rent. Theoretically, there is no minimum rent that can be charged but if it is deemed to be less than market value, this constitutes a 'gift without reservation'. This means that if you both die within seven years, it could form part of the estate again in terms of IHT calculations.  
 

Gifting them your property
There is nothing to stop you from giving your home to your child/children as a gift while continuing to live there. In this case, stamp duty will not be payable. However, as you are still living there and have benefit of using the asset, it is classed as a 'gift with reservation' and will attract the pre-owned assets tax. If you both die within seven years of making the gift, IHT liabilities will still apply in full. But even if you make a gift of your house to your children and do not live there yourself, the seven-year rule applies. In simple terms, everything you have given away before the seven years, apart from the small tax-free amounts allowed each year will go back into your estate to be calculated for IHT. Bear in mind however that IHT is calculated on a tapering scale according to when you die within the seven years. For example, although maximum IHT - at 40% - is payable if you die within the first three years of making a gift, only 80% of this charge will be made if you die within three to four years. This tapers down to just 20% IHT if you die within six to seven years. You also have a personal allowance of £3000 per year for gifts.   This is known as a potentially exempt transfer.

When making a significant gift over this threshold in one year, you are also able to utilise the allowance for the previous year. When the property is sold, CGT will be payable on the gain - in this case the entire open market vale of the property minus the child's personal allowance of £8,800 (tax year 06-07). CGT is also index linked meaning that you don't pay tax on general inflation. Independent tax advice should be sought
.

Lending them money
On whatever basis you want to lend to your child it is a good idea to set down a repayment schedule from the start. If you prefer, this can be made legally binding with a ‘promissory note' available from a property solicitor.

Many parents will help their child by providing an interest-free loan. Alternatively, you could charge a token rate of interest – perhaps amounting to that which you have lost by withdrawing the funds from your savings account. If you want to set an example by charging marginal interest on the loan, you could set this in accordance with the Bank of England base rate, which is reviewed every month. If you elect to charge your child interest on the loan then you should also consider any potential tax implications associated with this income.

Alternatively, you could reflect your contribution by means of a ‘declaration of trust' – otherwise known as ‘deed of trust'. This is a private legal document separate from, but running alongside, the property deeds. Its purpose is to make any arrangement you have drawn up with your child legally binding. For example, if your contribution for the deposit was £8,000 the declaration of trust could state that you will reclaim £8,000 on sale of the house. Or you could use the document to reflect your contribution as a percentage of the property meaning you benefit from any proportionate rise in its value. For example, if you contribute five per cent as a deposit, you reclaim five per cent when the property is sold.

A declaration of trust may cost in the region of £200 plus VAT and is drawn up at the same time as the other property conveyancing.

Raising Cash for a deposit by taking out a secured loan
Secured loans are another way that parents can raise cash to help their offspring onto the property ladder. The advantages of secured loans are that they are fairly easy to obtain, you can borrow large amounts and the loan can be paid back over a long period, thereby reducing monthly repayments – but this will substantially increase the total amount of interest paid. This type of loan is only available to property owners or mortgage holders. 

The lender can forcibly sell your house to get their money back if repayments are not paid. The ‘secured' part of its name means the lender – not the borrower has security, as if there are problems, your home can be repossessed. As the loan is secured, the lender is relieved of most of the financial risks involved – they may offer attractive terms for the borrower on interest rates and repayment period. Loans secured against a property that is already mortgaged are known as second charges, whereas loans secured against properties that have no mortgage in place are known as first-charge. The amount that can be borrowed, the interest rate and the term available will depend on three factors: your ability to repay the loan, your personal circumstances and the lender issuing the loan. Warning: Your home may be repossessed if you do not keep up repayments on a loan secured against it.

To evaluate your options we recommend you speak to a professional advisor about remortgaging, equity release or a secured loan
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More Information about Parental Help for First Time Buyers 

Helping with the mortgage l Making a gift l Tax Implications of parents helping children l Legal Implications of parents helping children l Seeking out the right financial advice


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