From April 2017, the tax treatment of buy-to-let mortgage interest will begin to change – which means a mortgage that you take out now may be affected.
As part of the budgetary measures announced in parliament on 8 July 2015, full tax relief on buy-to-let mortgage interest will be phased out and replaced with a 20% basic rate reduction.
Find out more: Landlord tax relief restricted in July 2015 Budget
Though the changes won’t take place until 2017, and won’t be fully phased in until 2020, the majority of buy-to-let mortgages have an introductory period of at least 2 years. This means that you should take your future tax liability into account when planning your current purchase or remortgage.
Interest-only borrowers may wish to take particular note. One of the main reasons that interest-only mortgages are so attractive to buy-to-let borrowers is the tax relief that can be claimed on mortgage interest; when this perk is eventually withdrawn, some may find that other types of products are more suited to their needs.
Are interest-only mortgages still viable?
There are reasons to use interest-only mortgages beyond the perk that currently allows landlords to offset the entirety of their borrowing costs against rental income. These include:
- Monthly cost: Though they typically cost more in the long run, interest-only mortgages are still the cheapest option in terms of monthly cost. This gives you more disposable cash each month to set aside for emergencies, reinvest in your portfolio, or keep for yourself.
- Inflation: The capital value of property trends upwards over long periods of time, whilst the value of debt stays the same. As your property appreciates in value, the size of an interest-only will decrease in real terms, even though the nominal value remains static.
Alternative options: products
Repayment or part-repayment mortgages
With a repayment mortgage, you pay off the capital owed to your mortgage as well as the mortgage interest. This means that the interest charged gradually decreases, with the interest portion of each monthly payment shrinking in relation to the capital portion throughout the mortgage term.
A downside to this type of mortgage is the added monthly cost, which can eat into your profits. A middle ground between the interest-only and repayment options is the part-repayment mortgage, where only a portion of the debt is reduced. This tends to be less expensive than repayment mortgages in the short term, and less expensive than interest-only mortgages in the long term.
A further downside is that more of your cash will be tied up in equity, making it harder to access if you wish to reinvest it. As always, be sure to talk to an advisor to help determine if this is the right option for you.
The majority of lenders allow you to repay some of the capital on an interest-only mortgage each year without penalty. A typical amount is 10%; any higher, and you may incur early repayment charges (ERCs).
Some lenders, however, offer flexible loans that permit overpayments of any amount throughout the mortgage term. This means you can reduce your debt when you wish, without having to commit to capital repayments each and every month. It is also possible with some of these products to switch before the end of the mortgage term, again without penalty, if a better deal comes along.
Alternative options: investment strategies
Reducing your portfolio size
If you wish to reduce your overall debt but do not have the capital to make overpayments or switch to a replacement mortgage, you may wish to examine your portfolio and see if you could make one or more sales. This might involve disposing of properties that are less profitable than the others, or that have accrued less value – in any case, though, be sure to seek professional advice before taking action.
Bear in mind that, even if you are able to reduce your remaining mortgages, any overpayments or early switching might be subject to ERCs.
Becoming a limited company
Whilst buy-to-let interest relief is being withdrawn, corporation tax is shrinking – to 19% in 2017 and 18% in 2020. Mortgage interest can still be fully offset against rental income for corporation tax purposes; therefore, incorporating your properties into a limited company could be a more tax-efficient option for some borrowers.
There are several implications to becoming a limited company; some positive, and some negative. Read our article pros and cons of BTL through a limited company for an introduction to the subject, and as always, be sure to consult with financial professional such as an accountant or tax advisor before taking any action.