Pay off mortgage on rented house versus saving the momey

Mortgage rate = 3.99%
Savings you could earn = 2% gross (1.6% net, or 1.2% for higher rate tax-payer)

So your mortgage is costing you more than you can earn. But you need to factor in what tax you are paying as your mortgage allows you to benefit from offsetting the interest element against your tax liability.

If the mortgage is £100,000. You are paying 3990 a year in interest which is taken off your rental income and reduces your profits by 3990 and therefore the tax going to the government has been reduced by ([your tax rate] x 3990) compared to not having a mortgage.

If the mortgage was 90,000, your interest would only be 3,591 and so the tax saved over not having a mortgage is only [your tax rate] x 3,591.

From this, you can see that whatever interest you don't pay to the lender is going to cost you more tax to the government by [tax rate] x the interest saved.

If your tax rate is 20% then avoiding a 3.99% interest bill only saves you 80% of the 3.99% in âctual net costs.

If your marginal tax rate is 40% or 45% or more, avoiding a 3.99% interest bill only saves you 60% or 55% or less of the 3.99% in actual net costs.

So a high rate taxpayer would only save 2 point something percent in net costs. He might find that he can earn 2 point something or better in an ISA instead. Or he might have an appetite for risk and invest in a stock market ISA instead and get 10% plus in the good years.

Even if he can't, he might value a big pile of cash more than a lower mortgage. The idea that you can remortgage and get the cash back in an emergency is probably subject to paying some arrangement fees, and is only going to hold true while your house is in good condition, generating an income and perhaps you yourself are employed. This might not be the case in such an emergency where you really need the 10k you paid off the house in the good times.

So whatever the 'feelgood factor' about chipping down your mortgage it might make practical sense not to throw all your spare money at it.

However, one potential advantage of paying off the extra cash, even if you could invest the 10k at a decent rate elsewhere, is that you might be able to get the mortgage down below a better LTV threshold which could allow you to remortgage and shave half a percent or more on rate for the entire mortgage balance (not just the incremental amount you were paying off). So for example you think you'll pay off 10k to save 399 of interest, but actually you save that 399 *and* you save 50 on every other 10k of mortgage balance you have out there.

Clearly you need to do the sums, but the point about having a stash of cash on the side rather than a lower mortgage is not just about a specific number of pounds saved compared to an amount that could be earned - it needs to be considered in the context of your wider financial and lifestyle situation, and what provision you have for keeping up with payments during empty periods, doing renevations and repairs and decorations and improvements etc., and generally what savings or guaranteed income you have in case of an emergency elsewhere in your life beyond the rental business.

Lending against someone's residential home is generally lower risk versus lending to someone's property rental business.

For a house which is someone's only roof over their head and being paid for out of salary - if there's a problem with their salary (i.e. unemployment) you can be pretty sure they'll look to remedy it right away. If you assessed their circumstances as being good for a 75% mortgage on that property and they want to temporarily give you more of your money back now and perhaps re-draw it later - to some extent you don't mind what level the net borrowing is at month to month, you can just take their cash in the offset account and lend it on to another residential borrower at a similar rate.

If the offset account is instant access it's not quite as simple as that in terms of you lending it on, but generally residential mortgages for borrowers who are not sub-prime and are on reasonable LTVs, are 'safe as houses' (excuse the pun), and a lender can give them some flexibility.

However, if I lend money to someone's property rental business, and secure it on an asset which isn't the owners only residence and is merely one (perhaps one of several) which he hopes to finance by letting out and avoiding problem tenants and damages and void periods etc etc - the risk profile is very different and I'm less certain that I'll ever get it back without having to take posession and auction it off. I'm less inclined to offer flexible products.

I certainly don't want to be earning only 50p a year on someone's net borrowings of £10 for a few years straight while their business is good, and then suddenly have them withdraw £200k without consulting me to put into another part of their business and leave me a burnt out shell of a house to auction off.

This is speculation rather than actually from experience and I've never had cause to look for an offset BTL mortgage, but it makes some sort of sense to me. Perhaps you might be able to access such a product temporarily while being on a residential mortgage and obtaining consent to let?