Even if lending to a family member, you should consider drawing up a contract and getting it witnessed, suggests Which?’s Gareth Shaw in answer to a reader’s question
Q My daughter has just finalised her divorce and, with half the proceeds of the matrimonial home, she needs a substantial amount (about £50,000) to borrow from me so she can buy a new home. It will be a loan, repaying at least £100 a month, and so I wonder if this will attract inheritance tax or any other problem for me.
A With ‘the bank of mum and dad’ playing an increasingly important role in supporting children getting on to the property ladder, it has become essential to understand the wider implications of giving or lending money to your children.
If you were to simply gift your money to your daughter without requiring the money back, you’d be able to give her £3,000 (or £6,000 if you hadn’t given her any money the previous year), without it having any inheritance tax implications. This is your “annual exemption”, and allows you to give money away tax free.
The remaining amount would fall out of your estate for inheritance tax purposes if you survived for seven years after making the gift.
This is technically known as a ‘potentially exempt transfer’. Die before that seven-year period is up, and your estate could have an inheritance tax bill to pay, if your gifts and total value of your estate exceed your £325,000 inheritance tax allowance (or ‘nil-rate band’).
You’re planning, however, to loan the money to your daughter. This makes the amount you’re giving her a ‘gift with reservation’, which essentially means that you’re retaining an interest in the money your giving, even if you aren’t charging actual interest.
Therefore, the amount will remain in your estate for inheritance purposes. When you die, the executors of your estate will tot up all of the assets you have – savings, investments, property and this loan – and if the total exceeds your tax-free allowance, 40 per cent could be payable on the excess.
If you decide to charge your daughter interest, you may have to pay income tax on that amount, as it will be considered as taxable income.
There are a few things you should consider before you go ahead and lend your daughter money – such as drawing up a contract and getting that independently witnessed. You could ask a solicitor to do it on your behalf.
This may seem heavy-handed for such a close relationship, but we often see family relations strained through financial issues, so it may be useful to have an enforceable agreement in place. You should also ensure that a standing order is set up for you to receive repayments.
It’s also worth thinking about what will happen to the balance of the loan when you die.
In the arrangement you describe, it will take your daughter 500 months, or more than 40 years, to repay the loan in full. Will the loan be waived when you die? Will she continue to pay the money back to their other heirs of your estate, if there are any? This is something you should discuss and agree at the outset – and considering whether some or all of it will actually be a gift, that could fall out of your estate in seven years’ time.
There are alternatives to lending money directly. Guarantor mortgages are designed to help people with small or no deposits buy a property by having a parent use their property as security against a home loan, and agreeing to cover repayments if the owner defaults.
Your daughter could borrow up to 100 per cent of the value of the property she wants to purchase, negating the need for you to lend her money. After a while, as she has made repayments to reduce her mortgage and built up equity, she could remortgage to a standard home loan, so your property is no longer needed as security.
To qualify for one of these loans, you need to own a share of your property outright, which could be anything between 25 per cent and 60 per cent. And there are other versions on these deals, such as temporarily depositing savings with a mortgage lender over a fixed period, and earning interest during that time.
You can find out more at which.co.uk/guarantor
Gareth Shaw is Head of Money at Which?