Give your children a cheap mortgage

Inheritance tax planning

Most strategies to reduce inheritance tax (IHT) involve giving away assets and hoping you live the required seven years. Quite simple in theory but in practice people worry about more than just tax when they think about giving their hard earned cash away. What if something happens and you need the money back? Will it stop your children from reaching their full career potential? What if your child wastes the money or loses it in a divorce? If this sounds familiar then you need a plan to protect your wealth that has IHT benefits built in.

Options

You’re right to be concerned and you should only give cash away if you can afford to do so. If an outright cash gift is off the table, you could purchase the property yourself and allow your son to live in it. There are at least two problems with this plan. Firstly, assuming you own your own home, you’ll pay an extra 5% in stamp duty land tax (SDLT) and, secondly, if the property appreciates in value, you’re adding to your IHT problem.

The bank of mum and dad

Rather than playing landlord you could become the banker. That is, you could lend the money to your son, which he uses to purchase the property and bypass expensive mortgage rates. You can live off the repayments or save them for a rainy day.

As an added bonus you will effectively “freeze” the value of the loan for IHT purposes.

Example. Joan lends her son Lewis £300,000 to buy a house. They agree that Lewis will repay the loan at a rate of £500 per month. This is much cheaper for Lewis than a mortgage would be. The amount outstanding will be subject to IHT when Joan dies, but it shouldn’t increase and if she lives on the repayments it will decrease over time.

Note that in our example the seven-year rule doesn’t come into it because there are no gifts involved.

If, later down the line you become less concerned about divorce and needing the money, and more concerned about IHT, you can waive the loan and the seven-year clock will start at that point.

Your son should benefit from lower SDLT rates as a first time buyer.

The downside is that he won’t be able to use the bonus from any savings he has in a Lifetime ISA as these can only be used to purchase a property with a mortgage from a bank.

Making it official

To protect your money from creditors, divorce, etc. you’ll need official paperwork in place to document the loan. Work with a solicitor to draft a suitable loan agreement and make sure you’re registered as having a “charge” over the property. This means the debt is secured over the value of the property, i.e. your son can’t sell it and run off with the money. It also proves the amount of equity your son has in the event of a divorce.

You can charge interest on the loan if you wish but keep in mind that you may have to pay income tax on it, and eventually IHT if you have more than you need to spend.