Generations unite to beat soaring property prices

Parents are remortgaging their homes and taking on extra debt to help their children get on the housing ladder and avoid inheritance tax.

The Bank of Ireland launched a parent-aided 'first-time buyer' mortgage last week for the increasing number of couples drawing money from the value of their own homes to provide a deposit for their offspring.

The First Start scheme enables the bank to add a parent's income - less the annual mortgage payments for his or her own home - to that of the child when working out how much to lend. A father earning £35,000, who is making mortgage repayments of £3,750a year, would be worth £125,000 in buying power to his child. The offspring can then add their income to this, say £20,000, to produce a potential maximum advance of £145,000.

At more than seven times the first-time buyer's income, this is way more than normal. But David Bitner of The Marketplace at Bradford & Bingley says most first-timers would pay no more in mortgage payments than they do in rent.

'Someone paying interest-only on a £145,000 mortgage would have monthly payments of £590. But the average cost of renting a room in London and the South East is £400 to £500 a month,' Bitner says.

'If the buyer takes one or two lodgers, their rent will help pay the mortgage, and she might even be able to afford a repayment rather than interest-only loan.'

Guarantor mortgages that allow parents to add their earning power to that of their children have been around for a long time. But this new version has competitive interest rates - discounted by 1.65 per cent for two years, producing a current rate of 3.89 per cent, or fixed at 4.89 per cent for three years or 5.29 per cent for five years - and no extended redemption penalties. The child must be at least 21, and the parent 60 or less.

The property can be in the child's sole name, or jointly owned by the the child and parents. Bitner says: 'This has big implications for taxation later on, so parents need to think carefully about this.

'Any growth in the value of the property is only tax-free if the property is your main place of residence. So if a parent owns half, when the property is eventually sold, he may have to pay capital gains tax on half the growth.'

First Start does not, however, alleviate inheritance tax. Mike Boles, of Savills Private Finance, says house prices have risen so steeply that hundreds of thousands of families now live in homes worth more than £255,000, the level above which the tax is charged.

More than half of those approaching his firm for equity release want to give the resulting money to their children in the hope it will save them from a hefty tax bill. If a parent survives seven years after giving money, no tax is due on the gift when they die.

Such people assume they need equity release, but Boles says most are advised simply to remortgage with a normal 25-year loan. This gives them low fixed and discounted rates of about 4 per cent rather than a typical 7 per cent for equity release.

Boles cites the example of a widower who took out a £1 million remortgage on his £2m home. 'He is 70 and has taken a 25-year mortgage, paying 4 per cent, fixed for five years. He has given £250,000 to each of his two children, plans to spend a bit on holidays and the like, and is keeping the rest to meet the interest payments of £3,333 a month.'

The danger is that if the widower lives for a long time, he could pay more in interest than his children would in inheritance tax. However it is much more cost-effective than an equity release scheme, where the interest would roll up and start compounding.

'After 10 years on that basis, your loan would have doubled,' says Boles.

'Nor would you be able to draw down so much. Equity release companies will only lend 70 year olds about 30 per cent of the value of their property. Even at 85 you only get 45 per cent.'