New Landlord, Renting out home. Worried About Tax of Interest only vs Repayment

chrispepper1989

Hi Everyone,

I am a first time landlord and diving in a bit quick. I have an agreement in principle on a 4 bed house and I am trying to choose a mortgage.

My mortgage adviser has advised that I go with an interest only mortgage. First Question: why are BTL usually interest only? should i be scared of interest only?

She presented me with 2 options:

fixed rate (2 year) 2.99% (monthly £217) £2125 arrangement fee
fixed rate (2 year) 4.25% (monthly £301) no arrangement fee

And suggested the no arrangement fee as it works out cheaper over the 35year term. However if I overpay, and pay £350 a month for either then the one with the arrangement fee is much cheaper.

I was planning on overpaying anyway as I would prefer to be paying some of the mortgage back. However i was wondering how this effects tax calculations.

Second question My assumptions is it does not affect tax at all, because I can only write of the interest i am paying. But I *optimistically* wonder, if i was contractually obligated on a repayment mortgage would this total amount count as my expense? or is the chunks i am paying off still classed as income?

Third Question I am currently in full employment and have noticed that apparently I can pay the tax through my PAYe code this looks easier, anyone have experience with this? (I can not post the link as i'm new but i could provide a quote if need be)

Fourth Question It should rent out for £700pcm, does it make sense to overpay as much as possible, or does it actually make more sense to put it in a regular saver? For example I know HSBC have a regular saver that is 4% interest rate with a max monthly of about £250. If i went for the 2.99% mortgage does that mean it works out as saving more then its costing me? I would feel more comfortable overpaying as it seems less complicated financially but is it going to cost me in the long run?

Four b.)
I was also presented with a repayment option on both (same interest rate, 35 year term) and my mortgage adviser said It made no difference whether I picked a the repayment or the interest only, if i was planning on paying the repayment amount on the interest only, the only difference would be the minimum payment required. If this is true why would anyone pick a repayment over an interest only??? e.g. on the 2.99% rate I can pay £217 interest only / repayment £326. Apparently if I took the interest only and paid £326 it would in effect work out the same (i.e. I pay it off in the 35 year term) which makes sense on paper, but surely there must be a catch here because everyone would surely do it?

Final Question Any advice for a total rookie?

I appreciate any advice given, I know that I am learning this the hard way and possibly the most costly way, but if i don't dive in, I simply wont do it.

p.s. With both lenders I am allowed to overpay 10% of the total loan per year. So initially i could overpay more then I could earn in rent.

somethingcorporate

B2Ls are often on interest only because the use of leveraging (via mortgages) allows your own capital to go further. My B2L (as an accidental landlord) is on capital repayment. It doesn't really matter, unless you are making a business of it and looking to invest in further properties.

It only marginally impacts tax, you can only offset your interest. If you are on IO your interest charge stays the same. If you are on a repayment obviously the interest decreases as the capital is slowly being repaid.

We repay our profit (tiny profit) through tax codes. There is a question when you fill in self-assessment to get this done (which means you're paying in arrears). It's very straightforward.

It's up to you if you want to overpay. If your aim is to have a mortgage free property (and pay more tax because you are not incurring interest expense) then overpaying is going to get you there quicker. If you are looking to expand your portfolio quicker then any profit should be reinvested for a new deposit. If it's 4% in savings vs 3% in interest saving on mortgage then the logical thing to do is to save it (or invest it).

On your last question I think you have misunderstood it. If you go IO or repayment and pay back exactly the same figure you would in effect be overpaying your IO and would end up in exactly the same place whichever you picked. However, going IO gives you the least amount of expense that you have to commit - i.e. if you cannot afford to overpay in one month you don't have to.

I think most people go repayment because it is simplest and they just want to know it is being taken care of (or more cynically they lack the discipline to OP enough).

As a relatively new LL myself (3-4 years) I would suggest you do as much reading as possible, make sure you get your gas safety and insurance in order and treat your tenants with courtesy and respect. There is nothing like a slapdash, rookie LL to give all the ones that do care a bad name!

Alias_Omega

We ensured through maintenance and repairs that we paid no tax at the end of the year.

So choose wisely...

AdrianC

If you go interest-only, you'd usually either - as somethingcorporate says - overpay (effectively turning it into a repayment) or get some kind of saving product intended to repay the mortgage at the end of the term, such as an endowment.

If you don't, then - yes - you might well have to do some fast thinking in 25yrs time. An endowment or similar isn't guaranteed to provide enough to repay - it's just a savings pot alongside the mortgage. It might provide more, it might provide less.

Because the interest can be set against tax, it might seem logical that IO mortgages are preferred because the interest on the repayment savings pot is separate, so there's "more interest" to offset against tax. Except, of course, you're still paying tax on that interest on the savings...

getmore4less

You only work out over the fixed rate period not the full term of the loan
Whats the follow on rates?

She presented me with 2 options:

fixed rate (2 year) 2.99% (monthly £217) £2125 arrangement fee
fixed rate (2 year) 4.25% (monthly £301) no arrangement fee

Looks like you are borrowing £85k
1. 2.99% £212 pm ( £218 with the fee added)
2. 4.25% £301 pm

add the fess pay £301 on the first and after 2 years you owe £85147
Cheaper to take the higher rate

pay £350 and you owe.
1. £83,937
2. £83,776

still cheaper not to pay the fee

Also not sure if you can claim the full fee against tax if you can I think that needs a different calculation.

jjlandlord

chrispepper1989 wrote: »

fixed rate (2 year) 2.99% (monthly £217) £2125 arrangement fee
fixed rate (2 year) 4.25% (monthly £301) no arrangement fee

And suggested the no arrangement fee as it works out cheaper over the 35year term.

I wouldn't bother comparing over the 35 year term, as it is very unlikely that you will keep it that long.
Over 2 years the first one is marginally more expensive. I would check what happens after these 2 years.

The arrangement fee is a legitimate expense for tax purposes. In principle it should be amortised over the duration of the mortgage, though.

chrispepper1989 wrote: »

However if I overpay, and pay £350 a month for either then the one with the arrangement fee is much cheaper.

You don't overpay on an interest only mortgage, by definition.

chrispepper1989 wrote: »

Second question My assumptions is it does not affect tax at all, because I can only write of the interest i am paying. But I *optimistically* wonder, if i was contractually obligated on a repayment mortgage would this total amount count as my expense? or is the chunks i am paying off still classed as income?

You answered that yourself when you right wrote that you can only expense the interests.
Capital repayments are not an expense and thus not deductable from taxable income.

chrispepper1989

AdrianC wrote: »

so there's "more interest" to offset against tax. Except, of course, you're still paying tax on that interest on the savings...

somethingcorporate wrote:

It only marginally impacts tax, you can only offset your interest. If you are on IO your interest charge stays the same. If you are on a repayment obviously the interest decreases as the capital is slowly being repaid..

ah these 2 things helped the penny drop. So in a sense either way your paying the same tax (unless I suppose you get clever with isas), its just where you pay it. It sort of looks like, the tax would be more complicated on the capital repayment because your interest cost would vary? i.e you would have to recalculate your expenses each year. So perhaps it would make things easier for now to stick to IO and put what I would overpay into a reg saver.

Alias_Omega wrote:

We ensured through maintenance and repairs that we paid no tax at the end of the year.

So choose wisely...

I was thinking of doing the odd thing to it over the course of the year, is there a handy guide on what counts as maintenance / repairs and what doesn't? I assumed anything that wasn't essential would not be counted as expenses.

somethingcorporate wrote:

We repay our profit (tiny profit) through tax codes. There is a question when you fill in self-assessment to get this done (which means you're paying in arrears). It's very straightforward.

So as someone who has never filled in self-assessment, would I simply start requesting one of those forms, filling in and sending out each year? It doesn't look too difficult but the alternative looks slightly simpler:

Taxing rental income though your PAYE code
There is an alternative to filling in a tax return each year and paying tax under self-assessment. If you are an employee or a pensioner, and your income is taxed under PAYE, you may be able to pay the tax due on the rent through your employment or pension without the need to complete a tax return.
If the rental profit (gross income less allowable expenses) is less than £2,500 a year, and the gross rental income (before deduction of expenses) is less than £10,000 a year, you can ask HMRC to collect any tax due through your PAYE code. You would need to send the tax office a statement of your rental income and expenses each year. HMRC would then change your PAYE tax code to collect the additional tax from your employment or pension

somethingcorporate wrote:

I think most people go repayment ... (or more cynically they lack the discipline to OP enough).

Ok that was my only conclusion, which doesn't really make sense to me because you would just set your DD to the correct amount...I suppose costs change etc

somethingcorporate wrote:

As a relatively new LL myself (3-4 years) I would suggest you do as much reading as possible, make sure you get your gas safety and insurance in order and treat your tenants with courtesy and respect. There is nothing like a slapdash, rookie LL to give all the ones that do care a bad name!

Thank you, and thank you everyone, I really appreciate the comments. Its really helpful.

I don't really get the slap dash approach, I remember when I was a student we rented a place and the guy had not only done a stand up job making the place very pleasant in general but he had done loads of little things, like making sure their was some washing up liquid etc (things you forget you need during a move) and even gave us a little welcoming present and was always respectful and courteous to us. In return we treated his property with the up most respect and before we left we cleaned from top-to-bottom and even made sure that everything that was on the photo itinerary was exactly the same (down to the pan handle orientation ) just because we wanted to make him smile. I hope that's the kind of LL i can be.

chrispepper1989

one other thing, I am currently working and my wife isn't, she will manage the property but the mortgage would be in my name. Does it make any difference tax wise whether we class it as my income or hers? i assume not as presumably it counts as a joint income, even though it would be her only income.

I only ask because I wonder if it will technically push me into the next income bracket (i am currently on 29k in my day job)

Not trying to cheat the system or anything just wanting to do it as fair as possible.

Technically my wife is on maternity of a job that did pay 13k, but currently we are planning on her staying at home and using the income from the house instead.

pcgtron

If it's renting for 700 a month then the yearly gross figure is £8400
Deduct the interest on the mortgage £217 x 12 = 2604
Deduct other expenses - 10% letting agent fee (if you have one) 70 quid a month = £840. Gas safety certificate = about £50, other misc £100 for ease = 8400 - 2604 - 840 - 50 - 100 = £4806 that you need to pay tax on.
Add this to your 29k day job and you have 33806 which means you don't pay tax at 40% so approx £961 worth of tax to pay.

Obviously, these are rough figures and would go up or down depending on expense levels etc.

anselld

Alias_Omega wrote: »

We ensured through maintenance and repairs that we paid no tax at the end of the year.

So choose wisely...

So you ensured that you made no profit.
What is the point of owning a BTL which makes no profit?

Some people make the strangest decisions to avoid paying tax!

G_M

Good answers to your Qs above so I'll just add:

[FONT=&quot]New Landlords[/FONT][FONT=&quot] (information for new or prospective landlords)[/FONT]

[FONT=&quot]Letting Agents [/FONT][FONT=&quot](Tips for selecting, and tips for sacking them)[/FONT]