Is the time right for hereditary mortgages?

Hereditary mortgages were first introduced in Britain in 2006 when Kent Reliance Building Society launched a product designed to be passed on with the house as a child’s inheritance.

While the lender has long since ceased to offer the product (and Kent Reliance has also long since ceased to be a mutual with its sale to JC Flowers in July 2010) it is still considered a viable option by some.

The concept of giving debt directly to your children would no doubt horrify and repel many. Nonetheless, with house prices continuing to surge does the idea have some merit and could it actually increase in popularity?

Why they might be a good idea

There is a good reason why hereditary mortgages might be seen as attractive – housing is more expensive which results in ever older first-time buyers and the ability to pay back a mortgage over a longer term makes them more affordable.

One of the major benefits of hereditary mortgages is that it may also help younger people onto the property ladder sooner as the mortgage repayments are lower over an extended term as the debt burden will have been split between them and their parents.

For example, a £200,000 repayment mortgage at 3 per cent costs £644 per month over 50 years. By contrast over just a 25 year period, the monthly costs rises 47 per cent more to £948 per month.

This could definitely help young people become property owners sooner where higher prices might otherwise have restricted access due to affordability.

This is the most positive factor about hereditary mortgages, especially when considering the average age of first-time buyer is now 37. Anything that may help younger people into the housing market has to be considered as many may be permanently stuck in the rental trap.

And why they might not

However there are other factors to consider. Let’s imagine a child inheriting the house (and debt). If they do not want to live there then they have two options, to rent it out or to sell.

If they choose the first option, then while they may be considered to be on the property ladder, they will not actually be living in their own accommodation and so still stuck in the rental trap.

If they chose to sell the house they could end up with fairly little depending on how much of the mortgage was paid off and how property prices have changed since its purchase.

Though renting the property out could be the most sensible option, many younger people lacking knowledge of renting a property out may not want the personal hassle and sell rather than considering using a management agency as the thought may not have occurred.

The most obvious argument both against and for hereditary mortgages is that house prices can change rapidly.

On the negative side this is illustrated by the Japanese experience where in the late 1980s house prices were so high that 100 year mortgages were offered.

However the market crashed and by 2000 many people were in negative equity owning houses worth one tenth of what they were 10 years previously.

While house prices in the UK may not fall with such velocity, a re-emergence in Eurozone problems may force many house owners into negative equity and potentially arrears. So in many instances the product could be inappropriate.

But then if it did became popular it could be taken out by many families who otherwise would not be able to get a mortgage which in turn could result in debt being passed to a child who does not know how or does not have the means to repay it.

This could potentially fuel a smaller boom in the market however and as the consequences of a bank’s decision would not be known for a very long time the entire lending market could be undermined in the future.

Hereditary mortgages could also have the potential to expose a deeper problem in the UK housing market – the long term chronic undersupply that has led to overinflated prices.

Space for housing has always been limited in the UK by schemes such as the Greenbelt protection around larger cities.

Both these factors have pushed up house prices due to restricting the space available for new houses in the most desired locations. If nothing is done to avert the lack of supply in the UK housing market then house prices will continue to rise, further disenfranchising the younger generations.

The nays have it

So when you count up all the potential negatives maybe it is a good thing that hereditary mortgages are not already a main stream product.

It is certainly an interesting concept and could genuinely help some get their first house. It may also help smaller towns retain a larger workforce as young people have an incentive to stay if they own their parent’s house.

But it may also cause greater distortions in a market still recovering from the effects of the financial crisis and result in large debts begin handed to children who are unable to pay them.