Buy-to-let investors are taking cash out of their homes in order to pay down mortgages on their rented-out properties ahead of next week’s change to the tax rules, mortgage brokers report.
They say a combination of better rates for home-owner mortgages, coupled with a fear of the increasing tax burden on buy-to-let, is driving the trend.
From the new tax year – beginning Thursday, April 6 – higher-rate taxpayers can no longer offset all their mortgage interest against rental income before calculating tax due.
The controversial move, which applies only to private individual landlords and not to companies, means higher-rate landlords will start paying tax on money they give to the bank.
It will lead to higher tax bills even where investors are not experiencing any increase in income. The reduction in relief is being phased over several years (see table, below) and will be replaced by a 20pc tax credit. In theory this should mean basic-rate taxpayers are not impacted. In practice, however, many of the latter will see their “incomes” rise to the point where they are pushed into higher tax bands. Others will lose means-tested benefits without experiencing an increase in take-home pay.
Rental income is £18,000 and your mortgage interest is £12,000: what’s about to happen?
For simplicity’s sake assume you are a higher-rate taxpayer. Your mortgage interest is £1,000 per month and your rental income £1,500.
Here’s how the change will affect your take-home income. Before the changes, with 100pc interest relief, you pay 40pc tax on profits of £6,000. that leaves you with £3,600 take-home profit. After the change, when 100pc of the tax relief is lost (from 2020-21) your take-home profit drops to £1,200 (see the table for a full breakdown by year).
Scroll to the bottom of this article for a calculator where you can work out your own liability for future years.
How could it help to pay down your buy-to-let mortgage with money borrowed against your home?
This could only work if the interest rate on your main mortgage is substantially lower than the rate you would have paid on the buy-to-let. That’s because while you would have had some interest tax relief on your buy-to-let (especially in earlier years) you get none whatever on mortgage interest relating to your main home.
Mark Harris, chief executive of mortgage broker SPF Private Clients, said: “Residential mortgage rates are lower than buy-to-let rates so it makes sense to raise equity on your main residence.”
He highlights current differences between top owner-occupier and landlord mortgages. A borrower with 40pc deposit or equity could get a two-year fixed rate of 1.114pc as an owner-occupier, compared to 1.44pc for a buy-to-let deal.
On a five-year fixed rate basis the owner-occupier gets a rate of 1.7pc compaerd to the landlord’s 2.33pc.
Whether these lower rates would compensate for the loss of relief on the more expensive buy-to-let loans is down to the borrower’s mortgage debt and tax bracket, among other factors.
But the wish to pay down buy-to-let mortgages is not driven only by the loss of tax relief. Landlords are fearing that tougher lending rules will make it harder for landlords to obtain credit in future. Borrowing conditions for owner-occupiers are by contrast relaxing.
Mr Harris said: “The level of borrowing now achievable on buy-to-let is likely to be lower than what could be achieved 12 months ago, so in effect landlords are having to put more equity in.
“If they don’t have this spare money in savings then taking this out of their home is one solution.”
Ray Boulger of rival broker John Charcol pointed to another popular strategy being adopted by some landlords with just one or two properties. Here, if possible, part or all of properties can be given by one spouse to another in order to benefit from the lower-earning spouse’s basic-rate tax band.
This is likely to require the help of a conveyancer, he said. “It is technically possible to go through the process on a DIY basis but there is a risk you will do something wrong.”
David Whittaker of Mortgages for Business, a specialist landlord broker, said professional landlords were continuing to invest but were doing so through company structures rather than directly buying the properties as individuals. This means the tax relief is retained. “Most of our new business is now lending to companies,” he said.