Is this wise?

owitemisermusa

Hi there,

Q: Is it wise to overpay the mortgage on a rental property (let out to tenants)?

Danke!

OMM

dunstonh

With low interest rates, no. With high interest rates, yes.

It will increase your taxation but if you are close to negative equity you may feel more comfortable repaying some of the mortgage.

owitemisermusa

dunstonh wrote: »

With low interest rates, no. With high interest rates, yes.

It will increase your taxation but if you are close to negative equity you may feel more comfortable repaying some of the mortgage.

Thanks dustonh. Don't quite get the explanation though.

Also don't understand how taxation is affected.

Thanks.

dunstonh

don't understand how taxation is affected.

You are able to offset the interest you pay on the mortgage against the rental income. This reduces your tax liaiblity.

i.e. £600 rental and £400 interest only mortgage would mean a net income of £200. You only pay tax on that £200.

If you repay capital (either by a repayment mortgage or by lump sums) the amount of the interest being charged will reduce and therefore your net income will increase and your tax will increase with it.

That taxation coupled with low interest rates means that it may make sense to keep the money in savings or conventional investments.

unmissable

I am in a similar situation and here is how I worked out my logic.

Say you owe £100,000 on your mortgage. In one year you will pay (at approx rates) 6% to the bank. That equals £6,000 payed to the bank every year.

If I rent out (for me approx £1000 per month) My wife and I earn approx £12000 extra per year. Tax this at (worst) 40% and it equates to paying the tax man £4800 a year.

Since all interest can be 'claimed / offset' against your tax bill the choice is

Pay bank £6000 ayear

or

Pay taxman £4800 a year

Answer is it is better to stop paying the bank (ie reduce your mortgage) than pay the taxman.

Of course everyone has individual tax situations, but my actual circumstances only made this solution even better.

I would be pleased to hear anyone elses comments on this logic.

owitemisermusa

dunstonh wrote: »

You are able to offset the interest you pay on the mortgage against the rental income. This reduces your tax liaiblity.

i.e. £600 rental and £400 interest only mortgage would mean a net income of £200. You only pay tax on that £200.

If you repay capital (either by a repayment mortgage or by lump sums) the amount of the interest being charged will reduce and therefore your net income will increase and your tax will increase with it.

That taxation coupled with low interest rates means that it may make sense to keep the money in savings or conventional investments.

Thanks again. Now I understand what you mean.

As your mortgage reduces, your tax liability grows (as mortgage interest diminishes). I've often thought about that. Asking myself why aim to have a mortgage free property if the entire rental income will then be subject to tax.

All about "being smart with money eh"?

I've had the same views myself but you have kindly put them succintly into words.

Striking a balance between investing extra cash and putting oneself in a healthy position come re-mortgage time. If things go entirely pear-shaped only the fittest (those with healthy LTV) will survive.

Danke!

dunstonh

Any surplus funds you were going to use to pay into the mortgage can always be used for savings and investments (in particular the full ISA allowance). That way you build up the money if you need it.

Also, the rental yields on most UK properties are quite low now (hasn't kept up with rising house prices). So, a yield of 5% for example can be beaten fairly easily by cash savings and potentially with stocks and share ISAs.