How to keep it in the family

The borrower

Debra Butcher is a marketing consultant, 37, single and earning pounds 40,000. She is also her parents' landlady. Her parents retired last July and planned to sell their three-bedroom bungalow near Warrington to move to a more rural area: North Yorkshire, for example. The bungalow sold for pounds 54,000 within two days of being on the market. Debra's parents then changed their mind about moving to North Yorkshire.

Debra had just changed jobs and was thinking about letting her small Cotswold cottage while temporarily renting nearer Marlow, where she now works. The parents asked if they could move into the cottage. Debra moved out with her two cats to Thame, near Oxford, renting a property for pounds 675 a month, and the parents moved in.

Debra's parents have now been in the cottage for four months and have settled down. However, they cannot afford to buy the cottage (worth pounds 65,000 to pounds 75,000) nor anything nearby. They are currently eating into their capital paying off Debra's outstanding pounds 45,000 mortgage (pounds 365 a month, with the Halifax). If they want to stay, Debra says she "can't" sell to raise the capital to help her buy. What about a second mortgage?

The advice

In recent years, a growing number of people have chosen to let out their existing home while buying a new property, and lenders have taken an increasingly benign view of this practice. Lenders are now prepared to incorporate rental income into overall "affordability" calculations - multiples of income - for people who want to buy a second property.

In this case, Bristol & West, for example, would offer a second mortgage at its normal "first mortgage" interest rates and for up to 95 per cent of the value of the property, albeit effectively based on a slightly lower income multiple. It would deduct 10 per cent of the existing (first) mortgage balance from the income of a borrower like Debra before calculating how much it would lend. In this case it would mean knocking pounds 4,500 off her annual income. Debra also has a pounds 200-a-month car-financing agreement, which B&W would want to take into account. It would reduce her income by a further pounds 2,400 (the annual commitment to the loan). Together, this would mean Debra's income of pounds 40,000 would be reduced to pounds 33,100 for lending purposes. B&W would then lend her 3.5 times the reduced amount.

This would allow her to borrow up to around pounds 116,000 for the new property and this could be for up to 95 per cent of the property's value. Available B&W loans include 4.99 per cent fixed for two years, 5.89 per cent for three years, 6.29 per cent for four years, or 6.49 per cent for five years.

But the sort of property Debra wants would cost at least pounds 130,000. Debra has very little in the way of savings. Mr and Mrs Butcher senior raised pounds 50,000 from selling their own property and may wish to consider giving their daughter pounds 15,000 to pounds 20,000 to help her buy while remaining in the Cotswold cottage.

Debra may look at a five-year, capped-rate mortgage at 6.99 per cent. While costing slightly more than the equivalent fixed-rate deal, the rate has the potential to come down if, as expected, interest rates fall over the next five years.

A repayment mortgage of pounds 115,000 over 25 years would, at 6.99 per cent, cost Debra approximately pounds 820 a month, compared with the rent of pounds 675 per month she is currently paying. If Debra was to take the capped rate, interest rates would need to fall by 1.75 per cent before she started to see any reduction in costs.

If Debra is particularly positive about interest rates falling within the next two years, she might consider taking a two-year fixed rate at 4.99 per cent on an interest-only basis, which would cost only pounds 478 per month, saving pounds 200 a month compared with her rent in the short term. As she is new to her current job, she might expect a higher-than-average pay rise over the next two years, which would reduce the shock of any return to a variable rate at the end of the fixed-rate period.

Another positive point to note is that, unlike many purchasers in a similar position, Debra has the comfort of knowing that her tenants are already paying enough rent to cover the existing mortgage - and, hopefully, won't fall out with the landlord.

q Debra Butcher was talking to Simon Tyler of Chase De Vere Mortgage Management, 0171 930 7242.

If you want to be considered for a mortgage makeover, or a wider financial makeover, for publication - including a photograph - write to Steve Lodge, personal finance editor, Independent on Sunday, 1 Canada Square, Canary Wharf, London E14 5DL, or fax: 0171 293 2096 or 2098; or e-mail: S.Lodge@independent.co.uk. Please include details of your financial position and a daytime telephone number, and say why you think you need a mortgage makeover.