Opinions needed. Mortgage vs ISAs

PT1973

Hi,

Been following the boards for a while, but have got to a point where we need to jump in and get some feedback on a scenario we find ourselves in.

6.5 years ago I joined a smaller company, taking a 20% pay cut in the process. 5 years on and it has finally started paying off . Last year we managed to save around £30,000 thanks to profit share bonus payments, and this year currently looks like it could produce just over double that. (Touch wood!) It's a very privileged position to be in, and we don't know how many more years it may work out like this.

We couldn't afford to buy anything in London, so 3 years ago we bought a place in the Midlands, did some work on it and now rent it out. Idea being that it's an investment for retirement. Rent covers the mortgage, plus a little bit more which goes into a pot for repairs/work required by the tenant.

Outstanding mortgage is around £100,000. Value is around £145,000.

I am now a higher rate tax payer, but my wife works 3 days a week in a local school and runs a web based business at the same time. Her earning though are around £20,000.

Our initial plan was to put all the money from last year, and this coming year on the mortgage, as we can do unlimited overpayments from September 2011. We could theoretically clear the house in a single year, if we keep saving (and work continues to go well).

A finanical advisor told us that we should put the money in Cash ISAs, and a Stocks and Shares ISA. Increase Pensions, and keep the rest in savings. Rationale being that if the house is paid off then the rent of £6600 a year becomes taxable profit, but that it would be taxed at the higher rate due to my earnings. We have explained since that the house could be moved into my wife's name, and that would make a difference.

But what do any of you guys think... If the tenant is covering the mortgage, should we be just letting that run, and investing money in ISA and savings account, or should we pay it off. The maths seems to suggest that the £4500 to £5,000 we could earn on the rented house is higher than a savings based return given current rates. It also means the mortgage is gone in the event of any interest rate hikes due in the next years. Finally, we had 6 months without a tenant year before last, and had to find £3,000 to cover it. Current tenant appears to be long term, but who knows...

We keep going round in circles on this, so any help would be greatly appreciated.

Patrick

Spiggle

Hi Patrick,

For what it's worth with the numbers you're talking about I think you should take some more advice.

It seems a good idea to fill a cash ISA for each of you at the best rates you can and fill another for each of you when new tax year begins. I know nothing about S&S ISA so won't comment other than there is risk involved there.

You don't say whether the mortgage is interest only or repayment. And the fact that you did need to fund the mortgage when no tenant was in place is a risk you would have to keep in mind.

Is the mortgage an advantage i.e. against earnings/rent for tax purposes? Perhaps an accountant would give better advice than an IFA on that but I'm not sure. Certainly to my mind an accountant would have more options on the tax front.

If it was me (and it clearly isn't unfortunately ) I would be tempted to fill my cash ISAs for this year and next, make sure I had a good three to six months of a separate savings cushion in case of the worst happening, and then reduce the outstanding mortgage by as much as possible bringing it down to half or a third of its present level. You would then also have a superb LTV which has to be good in the long run. Because I'm risk averse and now hate having debt I would be tempted to clear it all but I'm not sure that from a tax perspective it would be correct. But this would give me peace of mind.

I'd ask an accountant to be honest. I don't want to offend anyone but an IFA will probably be trying to sell you something. The accountant can impartially advise and then you can approach an IFA when you know what you want.

So that's my completely amateur and personally biased opinion of what I would do but it's your decision in the end.

Good luck with it,
Spigs

Baby_steps_2

Hi,

The reason the IFA is advising you not to pay off the mortgage is because the mortgage interest is a tax allowable expense. If you have no interest then you can not claim this against any rental profit thus increasing any net profit and resulting in you having more taxable income. Even if you transfer the property to your wife you will still pay tax on any extra profit at the basic rate. (given your position even if you don't pay off the mortgage it may still be worth transferring the property to your wife’s name to reduce any tax liability you currently have as your a higher rate tax payer).

I would advise filling any cash ISA allowances first. If you are happy to take the risk then (and there is a level of risk) any extra into stocks and shares ISA as any interest earned will not be taxed. Then put the rest into other savings accounts (as much as possible in your wife’s name if you feel happy doing that), or pensions (although make sure you consider the fact you will not be able to access any you put in a pension until over 55) its worth seeking advice on the amount you can put into a pension as the tax benefit is only up to a certain limit these days and the rules have changed since I qualified so I'm not that clear on them these days.

If you then don't have a tenant for a year you can take the money out of savings (not the ISA accounts if you can help it) to cover any rental loss in the short term.

Spiggle

Baby_steps wrote: »

...The reason the IFA is advising you not to pay off the mortgage is because the mortgage interest is a tax allowable expense. If you have no interest then you can not claim this against any rental profit thus increasing any net profit and resulting in you having more taxable income. Even if you transfer the property to your wife you will still pay tax on any extra profit at the basic rate. (given your position even if you don't pay off the mortgage it may still be worth transferring the property to your wife’s name to reduce any tax liability you currently have as your a higher rate tax payer)....

That's what I meant - a tax allowable expense! Thanks Baby steps. :T

Spigs

PT1973

... Thank for your swift responses, and apologies for my tardy thanks!

I should've added a bit more info, the mortgage is interest only with up to 10% overpayment per year. It's up in September, and becomes standard variable, but with unlimited overpayments.

I think you're totally right about the issues regarding advice from a Financial advisor, as they have to make a living. We've contacted my wife's accountant in the hope of sourcing some more opinions.

We're still going round in circles on this though. If interest rates rise, we could end up paying out extra to cover the mortgage. If the tenant moves out and we struggle to find a replacement again, we could end up spending another £3,500 to cover an interest only mortgage.

If we paid off the entire mortgage by December, which is just about feasible), surely it's better to be earning the approx £4,500 after Tax and putting that into next years ISA entitlement, than setting up ISAs (Cash and Shares) and a Savings account given current interest rates.

The return on that money from this years interest is likely to be less than what we'd earn next year from the profit from the rental. Next year should (should - fingers crossed) be a similarly rewarding year, and We'd be ISA-ing and saving like crazy to try and build a deposit for a house for us where we work in the South East. We'd then either try and sell the house that's been paid off to decrease the LTV on a South East property, or keep it as a retirement investment, and have a higher LTV down here.

I hope I don't come across badly, as we know we're in a very privileged position at the moment. To be frank, I really don't want to be a landlord, as I agree with those that think the buy to let market (plus self certification mortgages) played the lead role in the housing bubble. There is however a real fear of where we'll all be in 15-20 years time as regards pensions.

Anyway, thanks again for your feedback. I'll post again with anything useful that the accountant brings to the table, as it may be useful to others.

Patrick

dimbo61

You need to think long term while you are making HAY so to speak.
Fill you cash ISA allowance this year ( up to april) and the same again after april so thats 2X£10200 or has it gone up and then overpay the mortgage or put money into S&S ISA,s