Bank of Mum and Dad: Potential pitfalls of parental lending

NatWest, HSBC, Nationwide… when we think of mortgage lending, our thoughts inevitably stray to the household names of the banking sector. But did you know that parents and relatives – also known as the Bank of Mum and Dad or BoMaD – are collectively the UK’s ninth largest mortgage lender? In fact, parents and grandparents handed over an astonishing £8.2bn to younger generations during the pandemic – 44% more than the previous year – helping thousands of people onto the property ladder at a time of skyrocketing house prices.

A strain on relationships

Admirable though BoMaD may be for their generosity, the transfer of such vast sums of money inevitably has the potential to cause conflict between older and younger generations. This is particularly the case where relatives intend the money as a loan to be repaid, rather than a gift, but this is not set out in a binding legal agreement.

Imagine this scenario. A couple have decided to lend money to their son and his wife for a deposit on a property, with the (verbal) agreement that it will have to be repaid once they have settled in and the property is furnished and decorated. In order to be offered mortgage finance, the son’s lender insists that the money be declared as a gift, even though they have agreed otherwise between themselves. Several years down the line, the couple’s daughter-in-law files for divorce and insists she is entitled to a 50% share of the sale proceeds – including half of the money loaned by her former parents-in-law. With the signed document declaring the money as a gift and no legal agreement in place, the couple have no way of proving the money was a loan and so lose many thousands of pounds intended for their retirement. This causes significant tension between the couple and their son.

Coming to an agreement

While it may feel unnecessary to draw up a legal agreement when lending money to your own child, try to think of it as an insurance policy. As a parent, of course you’re eager to help them onto the property ladder and give them a head start in life. However, it is also true that nobody knows what’s around the corner, so it’s always best to be prepared for the worst-case scenario.

The offer of a BoMaD loan can be made legally binding through a Loan Agreement, which sets out the mutual promises between the lender and the borrower, or a Declaration of Trust, which protects the interests and financial contributions of all parties with a stake in a house purchase. Making your agreement legally binding has many benefits. Firstly, it will ensure a scenario such as that outlined above is avoided, by ensuring that parents and relatives are entitled to recover the loan in the event of a relationship breakdown or other event. Secondly, it ensures the money is not treated as a gift for Inheritance Tax purposes.

The downside

However, since stricter lending criteria were introduced following the Mortgage Market Review (MMR) in 2014, many lenders will not offer a mortgage to somebody with outstanding debt. A parental loan falls into this category, which is why lenders will often insist any help from parents or relatives take the form of a gift. Lenders also view it as risky as it means a third party could potentially claim an interest in the property if the borrower defaulted on their mortgage repayments.

However, there are some lenders who will accept a mortgage application from somebody who has borrowed money via BoMaD. As a parent who is lending a significant sum of money to their child, you are quite within your rights to insist that they find a mortgage lender that accepts outstanding debt as part of their lending criteria and to document this requirement within the Loan Agreement or Declaration of Trust.

For expert legal advice and assistance in drawing up a legally binding Loan Agreement or Declaration of Trust, please do get in touch at enquiries@attwaters.co.uk or call 0330 221 8855.

Sources:

https://www.zoopla.co.uk/discover/first-time-buyers/what-s-the-minimum-deposit-i-need-to-save/

https://www.independent.co.uk/money/bank-mum-dad-borrow-family-help-money-inequality-wealth-divide-gap-uk-b1853387.html