Is a second mortgage a worthwhile investment?
A quarter of people aged between 20 and 34 are still living with their parents, having been priced out of the property market, according to charity Shelter.
Meanwhile, many people at, or nearing, retirement age are unable to buy a new home, deemed too old to borrow or stuck unable to pay off an existing mortgage, victims of the mis-selling of interest-only and endowment loans.
As a result, there has been an increase in the number of people opting to take out a second residential mortgage to buy an investment property that doubles up as a way of helping a family member move somewhere they would otherwise be unable to afford.
"Most lenders will offer mortgages on second homes subject to affordability," says David Hollingworth at mortgage broker London & Country. "We often see this with children helping their older parents out, maybe buying a place so they can live closer together."
Andrew Montlake, brand, marketing and communications director at broker Coreco, agrees: "A second mortgage can work very well for those who have good incomes and are looking to buy a property for a dependent relative. Borrowers are also using this to help their children to get on the property ladder with a joint mortgage, as well as to buy holiday homes."
He adds: "I recently arranged a loan for a client who was a partner in an accountancy firm and wanted to buy a property for his parents to live in. Given their age, this was proving difficult for them to do themselves. As affordability was not an issue for him, it was a good option for everyone. And as the son owns the property from the outset, there are no inheritance tax issues in the future".
How it works
A second mortgage works almost exactly the same as any other standard regulated residential mortgage, and most lenders will offer those looking for a loan for a second home their standard product range to choose from, with the same interest rates and fees.
However, they may cap their loan-to-value (LTV), or exercise extra-strict affordability criteria. Your lender may also require you to declare if your family member will live in the house and ask them to sign an occupier's consent form.
As an example, Barclays or Santander will typically lend up to 80% loan-to-value (LTV) on a second home, Halifax or Virgin 75% and Nationwide up to 85% LTV, though all will judge it on a case-by- case basis.
These are available on standard products, so at 80% LTV you could expect rates of about 2.5% for a two-year fixed-rate mortgage or 3.5% for a five-year fix. At 75% LTV, that falls to around 2% for a two-year fix or and just over 3% for a five-year fix.
Also beware that some lenders will not allow you to formally charge your family members rent. For example, a spokesman for Halifax says: "Applications where a tenancy agreement is in place between applicant and family member cannot be accepted. The mortgage can be used where a family member will occupy the property provided there is not a formal tenancy agreement."
NatWest does the same but that's not to say rent can't be charged; it just means there can be no formal legal contract in place between owner and tenant.
Lenders will assess your ability to repay a second mortgage in one of two ways, on a gross borrowing or an affordability basis.
Banks or building societies that focus on gross borrowing will decide whether they would lend you the debt you already have outstanding if it was combined with the sum you need for a second property.
Take a husband and wife who have a mortgage of £200,000 on their existing home and wish to borrow a further £150,000 with a second mortgage to buy their children a flat.
A lender may 'stress test' by working out if it would be happy to hand over a total of £350,000 to the clients using its normal criteria. If so, it will accept the £150,000 requested on a second mortgage. Smaller banks and building societies tend to go down this route, including Clydesdale Bank and Metro Bank Lenders such as Woolwich and Virgin Money look purely at affordability based on how much a borrower is already shelling out each month.
A bank would ask if the married couple could afford another £750 a month to repay a new £150,000 mortgage, when they already have to find £1,000 a month for their existing £200,000 mortgage, bearing in mind other expenses such as household bills.
Lenders may also want you to declare who will pay the running costs, bills and council tax of the second home and may take into consideration the risk of your family member being unable to meet these expenses.
Buy-to-let versus a second mortgage
Buy-to-let (BTL) loans are not regulated as residential mortgages because landlords are viewed as business borrowers who need less supervision than ordinary consumers. This means you cannot use a standard BTL mortgage on a property that you or a relative will live in.
BTL mortgages also come with higher interest rates and fees than standard residential loans. It is therefore very difficult to get away with renting to family, especially since lenders have tightened up on 'back door' BTLs and are 'quite hot' on tracking down BTL properties that break the rules, warns Aaron Strutt, product and communications manager at broker Trinity Financial.
Before April last year, when the Mortgage Market Review (MMR) was introduced, about half of lenders that offered BTL mortgages also offered a 'regulated' BTL loan that allowed you to name family members as tenants.
But since the MMR introduced stringent affordability tests, leading to lenders checking everything from the number of pets you have to the pints you drink on a Friday night, such loans have since been withdrawn.
"The problem is that with a regulated buy-to-let loan you must declare how much rent your family tenant will pay", says Alistair Hargreaves, mortgage and protection consultant at adviser John Charcol.
"Lenders worry that if your tenant is your child or parents this is not fixed and sometimes you may have to help them out with rent. With an ordinary tenant, if they can't pay you can turf them out but you're not going to leave your elderly parents on the street. Lenders consider this could put extra strain on people's finances and it's a risk they don't want to take."
Out of the 20 lenders that offer buy- to-let mortgages, only three now offer regulated buy-to-let loans.These are niche players Buckinghamshire Building Society, Newbury Building Society and Stafford Railway Building Society.
"We now recommend what we call 'dependent relative mortgages' instead", says Hargreaves.
"This is where a lender is fully aware you are buying another property with a second mortgage, which is regulated, for a close family member to live in."
With a buy-to-let loan, you can claim tax relief against mortgage interest payments, as well as the running and maintenance costs of the property. Second residential mortgages, on the other hand, can land you with a significant capital gains bill.
Alistair Hargreaves, mortgage and protection consultant at adviser John Charcol, explains: "Say you bought a cottage in Saffron Walden for £300,000 for your older parents that in the next five years goes up to £450,000, at which point you need to sell it to pay for care costs. This is not your main home, so you will be hit with a capital gains tax bill for the increase in property value. The same could be said if you bought your student child a home while he or she was at university."
There is a way round this with a product called a joint borrower, sole proprietor mortgage. This is offered by three banks – Woolwich, Virgin Money and Metro Bank. "This type of mortgage lets you put the property deeds in the name of the occupier, while you are still the mortgage holder for the purposes of having your credit file checked and being liable for the monthly payments," says Hargreaves.
"This means that the property is sold only in the parents' name, so there's no capital gains liability. It is worth speaking to a solicitor to see if this could be the best option for your family."
The practice of a dishonest salesperson misrepresenting or misleading an investor about the characteristics of a product or service. For example, selling a person with no dependants a whole-of-life policy. There have been notable mis-selling scandals in the past, including endowment policies tied to mortgages, employees persuaded to leave final salary pensions in favour of money purchase pensions (which paid large commissions to salespeople) and payment protection insurance. There is no legal definition of mis-selling; rather the Financial Services Authority (FSA) issues clarifying guidelines and hopes companies comply with them.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.