We frequently get questions at MoneyMagpie from concerned parents who want to help their adult children out. They often want to know how to pay off their child’s debts, without coming into difficulty with the tax office. It’s a subject we’re seeing more frequently now, too, as financially secure parents see their adult children struggle to get on the property ladder, get made redundant, or face mounting debts due to furlough or reduced working hours.
The rules around gifting money are complex, so throwing a remortgage into the mix makes it an even harder situation to navigate. Remortgaging is often touted as one way to raise capital. But is it a good idea – and should you do it to help out your children?
- What is remortgaging?
- Equity release options
- Inheritance tax rules
- A loan or a gift?
- Alternatives to remortgaging
- More useful reading
Many homeowners will remortgage at some point. It’s where you choose a new mortgage provider, and they ‘buy out’ your existing mortgage. So, you owe money to the new provider and not the old one.
It’s most commonly done when the end of a fixed term mortgage period comes to an end. Rates increase significantly after this introductory period, so it’s often cost-effective in the long term to switch and remortgage. You can get another fixed-term deal that makes your overall mortgage much cheaper. As you pay your mortgage off a bit before remortgaging, you also typically borrow less (and have better rates as you own more equity in the property).
Remortgaging to release capital
However, you can also remortgage to release capital from your home. This essentially extends your mortgage loan (or increases it with a new provider, if you switch) so you get a cash injection. So, instead of remortgaging to save money and reduce the amount owed, you get the same original mortgage (or sometimes more). In effect, you’re giving up some of the equity you’ve already paid for to get cash.
You often can’t remortgage for small amounts – such as below £25,000 – as this isn’t in the lender’s interests. For smaller amounts, you can set a personal loan against the house, instead.
Remortgaging to pay your child’s debts risks your own financial future. So, it’s really important that you consider all options before choosing this route. It’ll add significant cost to your lifetime borrowing – but it is often cheaper than a large personal loan.
If you’re over 55 and you own at least a portion of your home outright, you could consider equity release to pay your child’s debts.
This is like giving them a living inheritance, rather than waiting for them to inherit equity from your home when you die.
Equity release has had a bad reputation in recent decades, and it’s certainly not for everyone. However, if you need to release a lot of cash to help your adult child pay off their debts, or help them avoid debt, it could be a solution for you.
Unlike a traditional mortgage, equity release is known as a Lifetime Mortgage. You borrow against a portion of your home to release money. However, you can choose whether to make monthly repayments (like a normal mortgage), interest-only repayments, or nothing. The proceeds of your property sale when you die pay off the loan.
Equity release providers offer a no-negative equity guarantee. This is REALLY important to look for when you’re considering equity release. It means that, if the value of your property falls and the proceeds of the property sale aren’t enough to cover the loan, your loved ones won’t have to pay extra out of their own pocket.
You can give up to £3,000 a year to family members as a gift that won’t be affected by Inheritance Tax. However, any more than that could end up falling under IHT rules. If you die within 7 years of a larger financial gift, a tapered tax allowance is applied.
That means the person you gave the money to five years ago – who’ll likely have spent it – will end up with a large IHT bill.
You can give larger, regular amounts as gifts but ONLY if it isn’t to your detriment. Remortgaging specifically to pay off your child’s debts isn’t seen as ‘normal expenditure of income’ for IHT purposes. So, they’d have to pay IHT if you died within 7 years of the gift.
You might worry that your child will be left with a large IHT bill if you die within 7 years of gifting them money. However, if you wait to leave it to them in your will, they will definitely have to pay full IHT tax up to 40%! So, gifting the money while you’re alive can significantly reduce the IHT bill and ensures more of your hard-earned wealth passes to your child.
Gifts from an estate worth less than £325,000
IHT rules only come into play if a single person’s estate is worth more than £325,00, including all property assets. For a married couple, they each get an allowance and can transfer to one spouse when the other dies, taking the allowance to £650,000.
There’s also the Nil Rate Band, adding an extra £175,000 from the primary residence into the pot.
So, if your estate is worth less than £325,000, you can give as much as you like to your children without worrying about IHT rules. You can pay your child’s debt without worry. However, if you’re expecting to go into long-term care in the near future, this can be seen as ‘deprivation of capital’ which affects your eligibility to state funding for your care.
There is one way around this weird gifting thing. You can act as a loan provider to your child instead of gifting it. So, you could remortgage your property to pay their debts and write up a formal agreement stating that it’s a loan.
However, if you state that the loan is interest-free and ‘repayable on demand’, it’s counted as part of your estate. So, when you pass away, any part of the loan remaining (which could, in theory, be all of it), is counted as your estate. The child you gave the money to will effectively owe the estate. If the loan is less than their portion of inheritance, that’s all dandy (they’ll just receive their portion minus the loan amount). If they owe more, they may have to repay the other beneficiaries of the estate.
Be very careful here: it’s a good idea to pay for legal and/or financial advice. You do risk falling under anti-avoidance rules if you haven’t sought reliable advice before doing something like this.
Your child might not have a huge amount of debt – so remortgaging isn’t the option. Also, it’s a big financial burden for you to take on – and it might not help your child take control of their debt situation if you give them money.
There are other ways to help pay off your child’s debts without remortgaging.
- Offer to help with childcare so they don’t have to spend as much on private or nursery care.
- Act as a guarantor to a consolidation loan for them
- Help pay for their child’s essentials to free up cash for debt repayments
- Pay for a financial advisor to assess their situation
- Research free debt advice and encourage them to seek help
- Help them find ways to make extra money
- Go through their expenses and help them create a budget.
Helping in this way can take the pressure off debt management while making sure they continue to take responsibility for their own money and expenses. Debt isn’t something to be ashamed of – especially after the coronavirus pandemic. Hundreds of thousands of people will be affected by lockdown, through furlough, redundancy, closing their business, and childcare costs. However, a lump sum to pay everything off might not help those who want to pay their debt off themselves. It also doesn’t teach better budgeting habits for those in debt because of excessive spending.
There are other complexities around giving money to pay off your child’s debts. It can upset other siblings or family members, for example. Check out these articles for tips about helping in other ways, like finding ways for your child to make extra cash to pay off their debt themselves.