Should you lend money to your children?

There are important factors to consider when providing financial support to children purchasing a property

Soaring house prices mean it’s becoming increasingly difficult for young people to get on the property ladder, and parents are playing a larger role in helping out their children financially.

While you can play an important role in helping your children to buy their first home, there are issues to consider if the process is to go as smoothly as possible, says Helen Morrissey, Personal Finance Specialist at Royal London.

“Making the decision to hand over a large sum of money, whether as a loan or a gift, is a major financial commitment,” she says. “Parents should be aware of issues such as the potential tax implications, and think about how giving away or lending a large sum could affect them further down the line if their circumstances change.”

By planning ahead and considering the various options, you can help your children get that all important first step onto the property ladder. Royal London’s Good with your Money: Five things to consider before opening up a branch of the bank of mum and dad guide gives some hints for areas to think about.

Decide whether the money will be a loan or a gift

Disagreements can occur when money is handed over without both sides understanding the terms. For instance, parents can hand over money believing it’s a loan to be repaid, whereas the child may see it as a gift.

Although it may seem a little formal, setting out expectations in writing can save a lot of heartache. It means both parties enter the arrangement with a full understanding of what is expected of them. If you’re unsure, you can seek legal advice to help draft the paperwork.

Work out if you can manage without the money long term

When deciding to give away or lend a large sum of money it’s worth considering that your financial circumstances can change. Children may initially be able to afford repayments, but what happens if they have children of their own? The cost of maternity leave and childcare can eat into budgets and compromise their ability to repay the debt.

Similarly, parents may also experience changing circumstances. A divorce, or time off of work due to ill health, can mean finances become stretched.

While making a loan now may be affordable, you should consider how a major life change might affect your financial wellbeing.

Factor in the potential impact on your tax position

There are several potential tax issues that should be considered before deciding to make a gift to support your child’s house purchase:

• If money is handed over as a gift then an inheritance tax liability could be incurred if the donor were to die within seven years of making the gift and their estate is worth more than the current £325,000 threshold. There are a number of different allowances available that can be used, and keeping a record of what gifts were made and when is useful.
  
• Parents who are named on the deeds of their child’s home, while already owning a property, may find they are charged the higher rate of stamp duty that applies to second homes.
  
• Parents who have a share in their son or daughter’s property may also have a capital gains tax liability if the home is subsequently sold at a profit.

Parents should be aware of issues such as the potential tax implications, and think about how giving away or lending a large sum could affect them further down the line

Think about how the repayments will work

Even if you lend money to your child and agree a schedule of repayments, it’s important to consider that they may not be able to keep them up. Long-term absence from work, or the loss of a job, could have a major impact on whether repayments can be made.

Such a situation can put your relationship under considerable strain, and you may find yourself under increased financial pressure as a result. Parents should ask themselves how they would cope financially if the money were not returned.

Consider what would happen if your child’s relationship status were to change

Helping your child set up home with a partner can be an exciting time, but what happens if they split up? While it can be a hard topic to broach, it’s worth considering when setting up financial support. Properties can either be held as joint tenants, where both parties hold an equal share, or tenants in common, where parties can specify their share in the property. If sold, each partner receives the share allocated to them.

If parents have contributed towards a deposit then legal support should be sought to get a declaration of trust beneficial interest in place. This legally binding document clarifies what each person has paid towards deposits, fees or mortgage payments. Should your son or daughter split with their partner, there’s a legal record of who has paid for what.

Cohabitation and pre-nuptial agreements can also be useful in terms of setting out how assets should be apportioned in the event of a break-up. It’s worth speaking to a solicitor about how to draft the documentation.

Make sure you’re well informed

There are other ways you can help your children onto the property ladder. You could act as guarantor, for instance, or utilise equity release. It’s a good idea to seek financial advice to help determine the most appropriate way to do this.