BTL - interest only or repayment

yorica

You've raised an important point JTW - Am I right in thinking it seems to contradicts what Jamesd mentioned in his last remark?

Many thanks for all your input thus far.

JimmyTheWig

yorica wrote: »

You've raised an important point JTW - Am I right in thinking it seems to contradicts what Jamesd mentioned in his last remark?

Yes, the posts do contradict each other to some extent, but agree on others.
We agree on the fact that the loan can be against either property to qualify to be offset against rental income.
But we disagree on whether a loan clearly taken out to buy a residential property can be used to offset at all.

I believe what I have said is correct, but it's not something that I've ever done - just something I've heard about previously. So if someone more knowledgable (and maybe Jamesd is that someone) could clarify that would be great.
Really you need to speak to a tax accountant. Note that it isn't really a question for a mortgage advisor, though they might know the answer.

JohnDoe1

Leon_W wrote: »

Personally I would go interest only, put the extra money aside, and if I so desired, repay a lump sum when the Early Repayment Charges finished or, if the mortgage has this feature, use any overpayment facility.

Even if you put the extra repayment money aside and use the overpayment facility, it's still more expensive that having a repayment mortgage, isn't it?

For eg.
My repayments are £600 and interest only is £430.
I take out an interest only mortgage.

If I saved the £170 (600-430) each month in the bank and at the end of the year I decide I can overpay all I have saved i.e. 170*12= £2040, am I effectively paying the same as repayment mortgage?

JimmyTheWig

JohnDoe1 wrote: »

Even if you put the extra repayment money aside and use the overpayment facility, it's still more expensive that having a repayment mortgage, isn't it?

For eg.
My repayments are £600 and interest only is £430.
I take out an interest only mortgage.

If I saved the £170 (600-430) each month in the bank and at the end of the year I decide I can overpay all I have saved i.e. 170*12= £2040, am I effectively paying the same as repayment mortgage?

Pretty much. The only difference is that with a repayment mortgage you will be reducing the interest you pay each month and with the savings method and an interest-only mortgage you will be increasing the interest you earn each month.
The difference is, then, the difference between your mortgage interest rate and your savings net interest rate. The chances are your savings won't earn as much as you pay on your mortgage so from a strict money point of view a repayment is better. But as Martin's old economics teacher would have said, you pay a premium for liquidity.
(And also, in this case, the OP may qualify for a reduction in income tax with the higher mortgage balance.)

Leon_W

Yes, it's more expensive JohnDoe but only by the difference between the interest rate you pay on the mortgage and the interest rate you receive on your savings.

You have to weigh that up against the fact that, if necessary, you can get your hands on the cash immediately and it's not tied up in the property where it might not be so easy to get back.

EDIT: Posted at the same time as the above which explains it probably better than my post !

JohnDoe1

Thanks guys.

How would I work out what the premium I am paying for having an interest-only mortgage.
So using the numbers as my example and say, my mortgage rate is 5% and my savings is 1.5%. How much extra am I paying per year for having the liquidity?

JimmyTheWig

JohnDoe1 wrote: »

How would I work out what the premium I am paying for having an interest-only mortgage.
So using the numbers as my example and say, my mortgage rate is 5% and my savings is 1.5%. How much extra am I paying per year for having the liquidity?

Average savings balance with interest-only during the year is £170 x 12 / 2 = £1020.
This is the same as the average mortgage reduction during the year with a repayment mortgage.

Assuming the 1.5% savings interest rate given is net of tax (e.g. in an ISA, in the name of a non-tax paying spouse or after tax has been paid) then the difference in interest is 5.0% - 1.5% = 3.5%.
So you'll be 3.5% of £1020 = £35.70 worse off over the course of a year with interest only.

JohnDoe1

JimmyTheWig wrote: »

Average savings balance with interest-only during the year is £170 x 12 / 2 = £1020.
This is the same as the average mortgage reduction during the year with a repayment mortgage.

Assuming the 1.5% savings interest rate given is net of tax (e.g. in an ISA, in the name of a non-tax paying spouse or after tax has been paid) then the difference in interest is 5.0% - 1.5% = 3.5%.
So you'll be 3.5% of £1020 = £35.70 worse off over the course of a year with interest only.

I don't really understand the average savings balance and the average mortgage reduction bits but if that final figure is right then that's really not that bad at all and totally worth serious considering for everyone!

JimmyTheWig

JohnDoe1 wrote: »

I don't really understand the average savings balance and the average mortgage reduction bits

It's the reason why many people get less interest on a regular saver account than they expect.

In this instance you are paying £170 a month into your savings account. In the first month you have £170 in there earning interest. In the last month you have £2040 in there earning interest.
Now, some people would expect to earn 1.5% of £2040, as that's how much they've saved. But for most of the year there wasn't that much in there. So you don't get the full annual interest paid on the final balance.
The average balance (add the balance at the end of each day and divide by 365) is around £1020, and that's what interest will be paid on.

jamesd

yorica wrote: »

You've raised an important point JTW - Am I right in thinking it seems to contradicts what Jamesd mentioned in his last remark

It does and I partially agree and partially disagree, I think I simplified too much and it's safer to structure it differently.

But I don't agree with JimmyTheWig about where the problem lies.

I think that JimmyTheWig is a bit wrong about the loan having to be used to purchase the BTL property. It's OK to take out a loan to extract money from the BTL business or avoid putting capital into it, provided the value is no more than the value of the property when it was put into the business. So you can take out a loan and use that to limit how much capital you're paying in. The initial BTL loan is clearly this sort of borrowing and the purpose is simply to avoid putting the full property value into the BTL business: that is, to acquire the property from you for the business. You're not forced to put the full equity in the property into the business just because you happen to have that equity. JimmyTheWig, do you agree?

However, JimmyTheWig does raise an important issue: the purpose of the residential borrowing. JimmyTheWig has a good point about how HMRC might view it. On reflection I agree that it's unsafe to do the residential borrowing increase for a new property and BTL switch at the same time and HMRC might not allow the deduction.

So structure it differently:

1. Take out a BTL loan that is easy and cheap to remortgage.
2. One day later take out a residential loan on a deal that makes it easy to remortgage and buy the residential property.

You now own both properties and have two things:

A. expensive BTL loan
B. inexpensive redidential loan.

To save the BTL business money:

3. Remortgage/increase the residential loan and use that cheaper money to reduce the BTL borrowing.

This clearly has an acceptable business purpose, reducing the cost of the business borrowing. Your deduction is now safe.

I'm not more experienced than JimmyTheWig in this area - just maybe read more widely at times - he's usually the expert and raised a good point.

JimmyTheWig, how many seconds would you wait before refinancing the business borrowing to a cheaper form? Initial term of the BTL deal? A week? Do you agree that the restructured approach is safe?