decision to make at 45 which will affect our retirement

shamac

We have a house, currently v successful full time holiday let. We have a btl mortgage on it which will be paid in 18 years time (hubbie and i currently both 45). We are renting currently but want to buy again. we have a good deposit and will get a mortgage to finish when we are 60 ish.

Here is the dilemma. if we sell the house we will get about 100k equity out of it. We can then be almost mortgage free and will have lots of saving potential so can build up the isas as the years pass. Would you do this or hold onto the house (which covers all costs and makes a small profit currently) which will then provide an income of approx 1k a month for our retirement years. We are worried that once the mortgage is clear, a big chunk of the profits will disappear in tax as we will no longer be able to offset the interest.

Any money will be fun money, we have good private pensions to cover our daily living costs so won't be dependent on this money. Running the holiday let is hard work so maybe we won't want the hassle of running it then. However keeping it means we will have 2 fully paid for houses to leave our 2 kids.

What would you do?.Thanks.

jamesd

Just in case you don't know it, you're only allowed to deduct the mortgage interest not the mortgage capital payments. If it's a repayment mortgage and you've been deducting the whole mortgage payment you've a mistake to correct with HMRC as soon as possible. I think that you know this, just want to be sure.

In part because of the tax treatment it's common for BTL property owners to use interest only mortgages. Then the whole mortgage cost can be deducted because it's conveniently all interest. And you can invest the money instead of using it on capital repayments that only save you the low mortgage interest rates.

If either of you is a higher rate tax payer the most efficient way to pay off a property is to use an interest only mortgage and take the 25% tax free lump sum from a pension pot, after contributing money that would have been used for the repayments into the pension. This way you're effectively getting tax relief on your mortgage payments. You'll need to pay into the pension a bit more than the mortgage repayment amount but in exchange you get the 75% left in the pension to provide ongoing retirement income.

For your new purchase again it's most efficient long term to invest via a pension or S&S ISA and use an interest only mortgage. Then pay off the mortgage at the end of the term from the investments.

To minimise investment risk and maximise the time for compound growth the optimal mortgage length is as long as possible. Ideally ending many years after the state pensions start so you can use your pension and investments to retire early, then later use the state pensions to do any mortgage clearing that you want to do. If you do want to have an earlier finish date, an interest only mortgage finishing well after the planned end date gives you lots of timing flexibility to use the investments at a time when the markets are high instead of possibly being forced to o it at a low time.

A further advantage of this sort of approach is that inflation gradually reduces the real value of the mortgage capital that you owe so it ends up being much cheaper when you do it than it is today. It takes just 2% inflation for 11 years to reduce the capital value to 80% of what it started at. A few years of high inflation can be of even more help.

What I'd do is pension contributions for all 40% income, stop paying any capital off the BTL property, use an interest only mortgage on the new property and S&S ISA investing to build up the money to combine with the pension lump sums to exploit the tax relief to make paying off the mortgages as cheap as possible.

Your kids may well not want to live where the properties are so don't rely on them actually living in them.

shamac

Wow, very comprehensive answer for that time of the morning, many thanks.

The btl is of non standard build, its a wooden house, so we had only one mortgage lender who would lend on it, the ecology bs, so we can'tchange to interest only. Yes, we are only claiming the interest part of the mortgage at the moment. How would that change things?

shamac

and yes, husband is a higher rate taxpayer.

jamesd

Since your husband is a higher rate tax payer the cheapest option to pay a new mortgage is to go interest only then use the pension lump sum to pay off the capital. Here's an example ignoring any investment growth.

Pay in £10,000 in a year.
Get £2,500 in tax relief added.
HMRC refunds £2,500 via income tax claim.
Pension pot now has £12,500 in it that cost only net £7,500 to put in there.
Take a 25% lump sum from age 55, that's £3,125 off the property capital.
Leaves £9,375 in the pension to produce ongoing income.

The main limitation is the need to pay in a bit over twice as much as the capital you want repaid, if ignoring investment growth. Since he's probably also making other pension contributions he may well be doing that already. There's also the absolute maximum of capital that can be paid off this way because of the £1.5 million pension lifetime allowance, which caps you at no more than £375,000 or lump sum to clear a mortgage, if you accumulated the 1.5 million.

This is a really tax-efficient way to clear a mortgage and boost pension income at the same time.

Given the restrictions on the BTL property there's nothing to be done about that - since you can't change the mortgage repayment is what it'll have to be.