The challenges facing the buy-to-let investor
By Paul Spann, Client Director at Brown Shipley.
Whether our client’s source of wealth stems from the sale of their family business or a fine piece of artwork, a common investment for many HNW individuals is residential property. After all, we all live in a house – its ‘real’ – and we like what we know and think we understand.
Strong growth once seen in the Buy-To-Let (BTL) market has begun to tail off in the last two years, as the impact from a gradual withdrawal of mortgage interest tax relief, stamp duty land tax (SDLT) reform and stricter mortgage underwriting rules begins to shine through.
“TAX DOESN’T HAVE TO BE TAXING”…THEY SAID.
Before April 2017, BTL landlords were able to deduct the full cost of mortgage interest payments from their rental income, reducing their tax bill. From April 2017 and until April 2020, transitional rules allow for a gradual phase down of deductible mortgage interest from rental income before tax is applied. Private landlords will then only benefit from a 20% tax deduction for mortgage interest relief, unable to deduct mortgage interest costs against profits.
As a consequence of this change, many BTL landlords paying higher rate income tax will see the profitability of their investment fall. As shown in the table below, under the old tax rules a private landlord and 40% tax payer with a rental income of £12,000 p.a. and mortgage interest costs of £5,400 p.a. would be left with an after-tax profit of £3,960 p.a. From April 2020, net profit would reduce to £2,880 p.a.
BTL Mortgage Tax Relief Changes
Monthly gross rental income
Assumes 40% Tax
Monthly mortgage interest
|Transitional Rules||New Rules|
|Mortgage Interest (3%)||£5,400||£5,400||£5,400||£5,400||£5,400||£5,400|
|Deductible Mortgage Interest||£5,400||£4,050||£2,700||£1,350||–||–|
|Taxable Rental Income||£6,600||£7,950||£9,300||£10,650||£12,000||£12,000|
|Tax on Rental Income||£2,640||£3,180||£3,720||£4,260||£4,800||£4,800|
|Mortgage Interest Relief||–||£270||£540||£810||£1,080||£1,080|
|Tax Due on Rental Income||£2,640||£2,910||£3,180||£3,450||£3,720||£3,720|
|Net Profit After Tax||£3,960||£3,690||£3,420||£3,150||£2,880||£2,880|
A simple reduction in the cost of borrowing can also make a significant difference. In our earlier example, even under new rules in 2020/21 a reduction of 0.75% to the interest rate would help to maintain the status quo and net profit at £3,960 p.a.
As well as being able to use a residential property to secure a mortgage loan, Brown Shipley can also use a client’s investment portfolio as collateral (a “lombard facility”). Without the need to incur valuation or legal fees and often at a rate of interest that is lower than a traditional BTL mortgage loan, the risk is borne by your investments and you remain “in the market”, able to enjoy any potential investment capital appreciation and income. Furthermore, you are still able to deduct an element of your mortgage interest against rental income under transitional rules and take advantage of future mortgage interest rate relief under the new rules.
GOOD REASON TO STAMP ONE’S FEET…
In April 2016, the government introduced a 3% surcharge on SDLT for second homes and BTL properties. Basic economics dictates that as transaction costs increase, sales of BTL properties will decrease, as investors weigh up the financial merits and future capital gain opportunities against the cost of buy-in. With slimmer profit margins to consider, it really is an old fashioned case of “caveat emptor”.
TIGHTENING THE BELT…
In January 2017 the Prudential Regulation Authority introduced stricter affordability tests for BTL mortgages. Focus now lies on a landlords experience and track record, their wider assets and liabilities and how a new BTL property purchase and mortgage loan ‘fits in’ with the total portfolio and aggregated debt levels. Martin Betts, Head of Credit Risk at Brown Shipley says “A portfolio of Buy-to-Let properties can often be an important component of wealth planning. We quickly develop a thorough understanding of our client’s circumstances allowing us to take a holistic view of the funding required. Individual, tailored and considered financing is our goal, backed by a flexible and streamlined approval process to meet your needs”.
Paul Spann, Client Director, 0161 214 6567
All lending is subject to qualifying criteria. Brown Shipley reserves the right to decline any loan application at its sole discretion. Think carefully before securing debt against your home. Your home may be repossessed if you do not keep up repayments on a mortgage or any debt secured against it.
No information from this article should be taken as tax advice. Tax information is based on our understanding of current tax legislation as of September 2018. Please seek independent tax advice from your accountant or tax adviser.
Brown Shipley & Co Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.