How parents of first-timers can be real bricks

With the average UK home creeping above the £200,000 mark, first-time buyers are in a difficult position. In 2005 the number of property newcomers shrank to a 25-year low, and, according to the Halifax, the average age of the first-time buyer is now 33.

London was the toughest area – first-timers stumped up £222,005 for a home. And in Gerrards Cross, Buckinghamshire, the average property price has reached 17.8 times the average first-time buyer’s income. Across the UK, the average first-time buyer deposit is now £23,967, with a gut-lurching £43,988 in Greater London.

It is perhaps not surprising then that parents are helping their children take the initial step on to the housing ladder in almost half of all cases, according to the Council of Mortgage Lenders.

Most parents choose to do so by helping fund the deposit. But mortgage brokers report that more parents are forced into the position of mortgage guarantor as the only way to enable their children to afford their own places. This is becoming especially frequent in higher price areas such as London and the south-east.

Loans for standard guarantor mortgages are assessed on the basis of the parent’s or close relative’s income – rather than on the income of the homeowner – to afford him or her a larger loan. If the offspring earns £20,000 and wants to buy a £300,000 London flat, there is no way banks will allow it (in the absence of a hefty deposit). But factor in daddy’s £100,000 salary, and they take a kindlier view.

Standard lending multiples are three and a half to four times income, maybe five times when the borrower is assessed on the newer “affordability” criteria adopted by some lenders.

Guarantors’ names do not appear on the mortgage deeds. They have no interest in the home. But should the borrower default, it is the parents the lender will come after. As Simon Jones, director of Savills Private Finance says: “As guarantors you get all of the pain if something goes wrong and none of the gain.”

Jones says both borrower and guarantor clients take their own independent legal advice to understand their rights and liabilities before committing themselves to this sort of business.

Joint ownership with children would give more control over the asset. But fewer parents and siblings choose this route as parents can end up with capital gains tax to pay – in the UK only first homes are exempt from CGT.

Most guarantor mortgages are also conditional on the borrower having prospects. Lenders want young people whose earnings are likely to increase substantially and who will be able to take on the mortgage entirely in their own right in three, four or five years. In some cases that can mean students can take out guarantor mortgages. But companies prefer graduates, ideally professionals with established, rapidly rising pay structures such as accountants and lawyers.

Lenders are reluctant to accept would-be guarantors close to retirement as their income is likely to drop dramatically. A few accept the already retired with large pensions. Those with £15,000 or £20,000 a year are likely to need the money to live off themselves.

You do not need to pay extra for a guarantor mortgage deal. According to David Hollingworth, head of communications at brokers L&C, companies such as Halifax and C&G give borrowers their keenest rates. However, with some smaller lenders, the choice of guarantor mortgage deals may be restricted.

In some cases, guarantors merely facilitate the loan. In others they contribute to the monthly payments.

Traditionally, the level of mortgage loan available via a guarantor arrangement has been limited by the guarantor’s existing commitments. Under a standard arrangement, if the parent has £100,000 of income but already has a £300,000 mortgage, under 3.5 times lending multiples he could guarantee his child for only £50,000 of loan.

Now, however, mortgages from the likes of Scottish Widows, Skipton and Newcastle building societies, allow “top slicing”. They assess the borrower’s income together with the guarantor’s as opposed to basing the whole thing on the parent’s finances. The latter merely top up the shortfall from the child’s income.

Where the borrower needs £100,000 but can only borrow, say, four times his £20,000 salary, or £80,000, the parent covers just £20,000. So, with the above example, where the parent has £50,000 to play with, this would easily cover the sum required by junior.

However Ray Boulger, senior technical manager at John Charcol, warns that the guarantor is still legally responsible for all of the loan.

Stretching things even further, Bank of Ireland Mortgages/Bristol & West’s 1st Start scheme takes both child and parental incomes into account but treats the parents’ mortgage similarly to unsecured debt, permitting Ma and Pa normally much greater borrowing capacity. The mortgage company reckons this up by considering the parents’ existing home loan at the Bank of England base rate – currently 4.5 per cent – then adding on 1.5 per cent, and deducting the annual interest debt from the parent’s gross income, then considering the remainder as the basis for a mortgage.

So if there is a £300,000 loan covered by a £100,000 salary, the total annual interest would be £18,000. Deduct this from £100,000 and the parent could support up to four times the £82,000 remainder. Whatever income the child has provides additional borrowing power.”

Under this scheme, the lenders insist parents and child share a joint mortgage. But relatives can avoid capital gains tax – payable on second homes – by giving the child sole title to the property. Parents’ names do not appear on the deeds.

Products from Coventry and Norwich & Peterborough building societies have a similar approach. Both top slicing and joint mortgage providers offer reasonable mortgage deals.

Parents wishing to lend a hand but unwilling to relinquish control of their money, could steer their children towards family offset mortgages, where family members link their deposit accounts to the child’s mortgage. So, with a £100,000 loan, if the mother has £30,000 on deposit and she forfeits the interest on this cash by depositing it in an offset account linked to the mortgage, the son or daughter only pays mortgage interest on the remaining £70,000. Unlike conventional savings accounts, there is no tax to pay. Yorkshire and Newcastle building societies are both in this market.

The downside is that family offset loans fail to help young people to increase the amount they can borrow.

This could be a good thing if doomster predictions about the property market come true. In any case, if you and your child do borrow a significant amount relative to income, it is wise to consider a fairly long-term fixed-rate mortgage that will protect against interest rate shocks.