Calculating whether or not to pay off BTL mortgage

gterr

Hi there,

We have an interest only mortgage on a holiday let business from Birmingham Midshires. It's a tracker and we're currently paying 4.35% above BBR, which will fall to 3.99% above BBR in November 2013, which is also the date on which early repayment penalties would cease. The mortgage is for £51k, and will run for a maximum of another 6 years. We now have the £51k needed to pay off the mortgage, and this is ring-fenced in cash-based savings.

I was planning to pay off the mortgage as soon as the period of early payment penalties was over: November 2013. However, both my accountant and an IFA I saw yesterday said No, because it's a business and I'm getting tax relief on the mortgage payments it's best to keep it going for as long as possible and keep the £51k in savings earning interest.

But is this really so? I did rough sums last night and I've calculated that we're paying about £2484 per year on the mortgage, so taking into account tax relief I believe we're paying the equivalent of approx £1987 per year. I can't see that £51k in savings is going to be able to bring in more than £1987 after tax. I've even tried to simulate the effects of compounding the savings interest over 6 years and it still seems to show that we'd be better paying off the mortgage at the earliest opportunity.

Am I missing something?

kingstreet

What's your marginal tax rate? 20%, 40%?

getmore4less

Whats the penalty for paying off the debt.

Whats the max overpayment without penalty

marginal tax rate

2 year savings account might be worth looking at.

Any of the money in ISAs or are ISA allowance available ( might be 2 lots or 4 if partner.

gterr

Thanks for your replies.

20% tax rate

Penalty for overpayment prior to Nov 2013 is about £1500 (could check if this is critical, but I wasn't contemplating repayment until after this date anyway).

No penalty for early repayment after Nov 2013.

Of the £51k needed for the mortgage repayment, £30k is in a 2-year Post Office bond at 3.9% (matures end of Oct 2013) and £21k in Saffron BS easy-access online saver, currently 3.15%

Have already made max cash ISA contributions for this year.

holly_hobby

If you are happy to dispose of your capital savings by repaying your commercial borrowings there are a few issues to consider.

1. If following the redemption of your comm. mge you wished to withdraw capital from the business, it may be a little restrictive re lender sourcing, if the mge is totally repaid & property is unencumbered (esp if this is your only mortgage liability). So you may wish to consider leaving a small residual mge to account for this possible future requirement.

2. If you also have a residential mortgage, and you are looking to reduce your liability exposure as a whole, I would instead consider using the 51k against this debt, which does not receive any tax incentives/breaks, rather than dispose of a debt that does bring tax advantages (albeit on the interest element only).

3. Whichever route chosen, remember to reserve an emergency cash fund from the 51k (if this is the total amount of savings you hold) - which would be considered sufficient for both personal use & any emergency 2nd property issues/repairs.

Going back to your original post, and looking at this in isolation - whether its financially beneficial to repay your tax efficient mortgage or retain the savings instead, all hinges that any gted net return that can be acheived over the remaining 5 yr period from oct/nov 2013 (end of PO Bond & ERP period), is at least equal to the tax that may be offset re the I/O element of the mge payment.

That will need a full market sourcing exercise by your IFA, to determine if there is a current product in the market place, that is consistent with your risk profile (which appears form your post as low/cautious) - and gted to produce the net return reqd over the given period to make it a preferential choice to total or partial repayment.

If, bearing in mind the points raised through this thread, you still wish to proceed with your redemption (post cessation of ERPs), you will really need to make an appointment with your FA or an IFA to source (any) suitable recommendations.

Hope this helps

Good luck ....

Holly

gterr

Thanks, Holly,

holly_hobby wrote: »

So you may wish to consider leaving a small residual mge to account for this possible future requirement.

Good point, thanks.

holly_hobby wrote: »

2. If you also have a residential mortgage

No other mortgage, and no significant capital outlays planned.

holly_hobby wrote: »

3. Whichever route chosen, remember to reserve an emergency cash fund from the 51k (if this is the total amount of savings you hold)

Yes, indeed. We have about £20k in cash ISAs.

holly_hobby wrote: »

Going back to your original post, and looking at this in isolation - whether its financially beneficial to repay your tax efficient mortgage or retain the savings instead, all hinges that any gted net return that can be acheived over the next 6 yrs, is at least equal to the tax that may be offset from the I/O element of the mge payment.

That will need a full market sourcing exercise by your IFA, to determine if there is a current product in the market place, that is consistent with your risk profile (which appears form your post as low/cautious) - and gted to produce the net return reqd over the given period to make it a preferential choice to total or partial repayment.

Yep, we are cautious. There's no way I'd consider investing in a product that could not at least guarantee the minimum capital of £51k at the end of 6 years. I'm guessing that 6 years is a bit short anyway for anything other than cash-based savings (?)

holly_hobby wrote: »

If, bearing in mind the points raised through this thread, you still wish to proceed with your redemption (post cessation of ERPs), you will really need to make an appointment with your FA or an IFA to source (any) suitable recommendations.

Not sure quite what you mean here, Holly. If we wish to redeem do we not just go ahead and use the £51k savings set aside for this and deal with Birmingham Midshires directly? What other issues might there be?

Going back to basics, though: am I right in thinking that the tax relief we get on the mortgage payments is not going to be worthwhile given what we could get by keeping the £51k in cash-based savings for 6 years? My calculations appear to show this, and I used a generaous 4% gross for the cash savings rate, and assumed that bank base rate did not rise (mortgage is a tracker). Just wondered if I was missing something since both accountant and IFA were so clear that we should keep the mortgage - even before looking at figures.

Many thanks for your time.

holly_hobby

gterr wrote: »

Not sure quite what you mean here, Holly. If we wish to redeem do we not just go ahead and use the £51k savings set aside for this and deal with Birmingham Midshires directly? What other issues might there be?

Was referring to sourcing investment vehicles for your capital, if you elected not to redeem your mortgage.

gterr wrote: »

Going back to basics, though: am I right in thinking that the tax relief we get on the mortgage payments is not going to be worthwhile given what we could get by keeping the £51k in cash-based savings for 6 years? My calculations appear to show this, and I used a generaous 4% gross for the cash savings rate, and assumed that bank base rate did not rise (mortgage is a tracker). Just wondered if I was missing something since both accountant and IFA were so clear that we should keep the mortgage - even before looking at figures.

Many thanks for your time.

You need to compare net returns on investments for an accurate comparison on whether its more advantageous to either repay the mge, or retain all or part or your savings - as per your original post.

Which is where crunching some figs with your adviser will be of benefit - their advice to keep commercial borrowings os is generic good tax planning practice, but whilst clearly tax efficient does not always result in a overall monetary saving (esp for those with a tax band of 20% or those with total annual income below PA allowances). So whether retention of comm borrowings (over repayment with free capital) produces monetary benefit, is wholly dependant upon the individuals tax status, amount of borrowings classed as a permitted deduction, and of course HMRC regs at the time of advice and ongoing management of the arrangement.

Hope this helps ..

Holly x

gterr

Thanks for your time, Holly.