Parents are being urged to seek legal advice before lending money to their offspring and their partner – or risk losing it in the case of divorce or death.
Michelle Hamilton-Graney, private client solicitor at Merseyside law firm Kirwans, said that, with many children starting the search for their first home this month, parents eager to help should be aware of the pitfalls of lending without a legal document in place.
Without a written agreement, she said, those lending through the Bank of Mum and Dad have to accept that there is no legal requirement for either the child or their partner to repay the money, and parents could lose their life savings as a result.
The perils of unofficial lending became clear last year when an elderly woman lost her life savings after lending her son a six-figure loan to buy a property. When he died, his widow argued that the money had been a gift. The Judge ruled there was no written acknowledgement of a loan by the son, and the mother, who represented herself in court, was ordered to pay £100,000 in legal bills.
In addition, a report by Legal & General found that the average contribution of families and friends helping their loved ones to buy a home had increased by £6,000 to £24,100, effectively making the Bank of Mum and Dad the 11th largest mortgage lender in the UK, with one in five of every property purchases being part-funded in this way.
Michelle said: “The Bank of Mum and Dad has become increasingly important to people for a number of reasons, whether that’s to get on the housing ladder, extend a property, go to university or even to fund a year out.
“However, situations can quickly change, and what initially seemed like a straightforward loan can suddenly become an expensive legal battle as parents try and claw their money back from ex-partners of their children or other relevant parties.
“Creating a legal loan agreement between parents and children is a relatively straightforward process, but it’s one that must be signed off by a solicitor in order to ensure that the money will eventually be repaid.”
Here, Michelle suggests seven key points to consider before lending money to offspring:
Key questions when lending money to children
1) Will they ever be able to pay it back?
It’s one thing if you’re lending your children money, say, to go to university and you’ll be able to cover any shortfall on the repayments with your own earnings, but quite another if you’re retired and you’re lending your child a deposit for a house that they will then jointly own with their spouse or partner. Evaluate the circumstances and the probability of the loan being repaid, what you can afford to lose, and then make your offer based on those facts.
2) Do you need a legal agreement?
If it’s important to you that the money is repaid, then you absolutely need a legal agreement. While most people would never expect to sue their own child, the very fact that that document has been signed will often be enough to make it clear that you’re serious about repayments. A legal agreement really comes into its own, however, when a third party is involved. Say you lend your child the deposit for a home, they marry, then divorce, and the house is sold with your money still tied up in it. A legal charge can be put in place to ensure the money is returned to you rather than being split between your child and their ex. It’s also important to consider what would happen in the event of a fire, or the repossession of a home.
3) What will happen if they default on the loan?
This is an important point to consider; will there ever be a penalty for defaulting on the loan? And how quickly do you expect to have it paid back? What are the repayment terms? Discuss these points with your child and then make them official with a legal agreement.
4) Are there tax implications?
If the loan agreement involves the lender receiving interest, then they must inform HM Revenue & Customs so that it can be assessed for possible taxation. They must also declare any interest received on their self-assessment form as taxable income.
5) Is it actually a gift, or a loan?
A sum of money up to the amount of £325,000 can be given as a gift without being subject to inheritance tax – as long as the person giving the gift lives seven years after it is given.
Alternatively, up to £3,000 per year can be given as a gift without it incurring any tax, and up to £5,000 can be given as a wedding gift by a parent to their child.
6) A loan still forms part of your estate for inheritance tax purposes
If you die before the loan has been repaid, then it will still form part of your estate for inheritance tax purposes. Only if the debt is waived and becomes a gift will it no longer be considered part of your estate, but you will need to live for a further seven years from the point at which you officially waive the debt in order to avoid inheritance tax.
7) Would it make more sense to loan the money to a trust?
By setting up a trust in the child’s name and loaning money to it, the child could benefit from interest gained on the funds, but the capital would still be accessible by the parents should they need to withdraw it.