As announced in the Budget, mortgage interest rate relief is going to be limited to the basic 20% income tax rate: higher and top rate tax payers no longer get full relief.
The government has now published the detail of how the change will be phased in here which says
- in 2017 to 2018 the deduction from property income (as is currently allowed) will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate tax reduction
- in 2018 to 2019, 50% finance costs deduction and 50% given as a basic rate tax reduction
- in 2019 to 2020, 25% finance costs deduction and 75% given as a basic rate tax reduction
- from 2020 to 2021 all financing costs incurred by a landlord will be given as a basic rate tax reduction
Here’s a quick illustration based on a mortgage costing £8,000 p/a (which would be, say, £200,000 mortgage at 4.00%):
| Tax Band Qualification - 40% tax | |||||
| Tax rate | 2016-17 | 2017-18 | 2018-19 | 2019-20 | 2020-21 |
| 0% | £8,000 | £6,000 | £4,000 | £2,000 | £0 |
| 20% | £0 | £2,000 | £4,000 | £6,000 | £8,000 |
| Income tax | £0 | £400 | £800 | £1,200 | £1,600 |
The standard minimum rent required is 125% of the mortgage interest, at a notional rate of 5%, which for this loan would amount to £625 per month, or £7,500 per year.
If the property brought in that minimum here’s how it would look under both current and new tax regimes (and assuming the full 10% wear & tear allowance is used):
| with 40% relief (current) | with 20% relief (new) | |||||||
| Income | £7,500.00 | Tax due | Income | £7,500.00 | Tax due | |||
| Wear & tear | £750.00 | £0.00 | Wear & tear | £750.00 | £0.00 | |||
| 0% tax | £4,800.00 | £0.00 | 20% tax | £4,800.00 | £960.00 | |||
| 40% tax | £1,950.00 | £780.00 | 40% tax | £1,950.00 | £780.00 | |||
| Total tax liability | £780.00 | Total tax liability | £1,740.00 | |||||
| Total costs | £6,330.00 | Total costs | £7,290.00 | |||||
| Profit | £1,170.00 | Profit | £210.00 | |||||
The new tax rules cut the profit dramatically, and any unexpected expense could easily push it into a loss.
So what can landlords do to protect themselves?
The most obvious answer is to increase the rent, if the market will bear it. Since just about all landlords are likely to face the increased tax it wouldn’t be surprising to see rents generally increase over the next few years.
But that can only go so far before rents become unaffordable: public sector workers, for example, restricted to 1% pay awards will clearly have a limited capacity for increased housing costs.
Some properties simply may not be profitable, so it’s important to plan ahead and be realistic. Surely it would be better to divest those properties in a considered way than get caught up in a fire sale once the new rules bite.
The other solution is for landlords to cut their mortgage costs. Since it’s the mortgage that attracts the tax relief that may seem counter-intuitive, but of course any tax benefit only equates to part of the mortgage cost (be it 40% as now, or 20% in future), but you still have to pay the full mortgage.
Put another way, not paying 40% of something is never as good as not paying 100% of it!
Here’s a quick illustration of how different mortgage rates affect the overall profitability
| Interest rate | 6.00% | 5.00% | 4.50% | 4.00% | 3.50% | 3.00% | 2.50% |
| Mortgage | £100,000 | £100,000 | £100,000 | £100,000 | £100,000 | £100,000 | £100,000 |
| Rent p/a | £8,400 | £8,400 | £8,400 | £8,400 | £8,400 | £8,400 | £8,400 |
| Mortgage cost p/a | £6,000 | £5,000 | £4,500 | £4,000 | £3,500 | £3,000 | £2,500 |
| 20% tax | £1,200 | £1,000 | £900 | £800 | £700 | £600 | £500 |
| 40% tax | £960 | £1,360 | £1,560 | £1,760 | £1,960 | £2,160 | £2,360 |
| Surplus after tax & mortgage | £240 | £1,040 | £1,440 | £1,840 | £2,240 | £2,640 | £3,040 |
The coming tax changes give landlords a big incentive to review their portfolios, and financing is a key part of that. Getting the right mortgage could make a huge difference.
YOUR HOME OR PROPERTY MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE
