Rental Investment: Should I pay off rental mortgage early?

debt-freeoneday

Hi there

I hope I've posted this in the right forum, apologies if not. I'm looking for some advice...

I'm 34 years old, husband is 37. We made some pretty big financial mistakes earlier in life and ended up in a debt management plan. Just about to come out of that having almost paid off £41K in credit card and loan debt in the last two years.

We're now looking to the future and wondering what to do next. As yet, we have no retirement savings, but we do have two rental properties, each with mortgages on which we had from before our debt management plan.

Property 1: Mortgage amount £132K interest only - property value estimate £135K (was worth £150 a few years ago before the decline in the market). Rent covers interest only mortgage but not repayment.

Property 2: Mortgage amount £34K repayment - property value £60K. Rent covers mortgage with £200 to spare.

These properties bring in a combined income of £1100 per month. Obviously we pay landlord insurance and there are other repair and maintenance costs that we sort out.

It's our intention that these properties form part of our retirement fund in the future, once they are paid off.

We're thinking about aggressively paying down these mortgages soon with a view to having them both paid off in 6-7 years, which we think is doable. If we were to pay them off, we'd benefit from the additional income well before retirement.

However, we don't own our own home that we live in and this is the sticking point. We currently rent and because of the DMP, we'd struggle to get another mortgage anyway for the next few years. Also, I'm self employed and don't earn all that much on paper, hubby is a director of his own company but takes a low salary because of money being reinvested in the company.

If we were to get a mortgage to buy our own home, we'd have to save a huge deposit within the same kind of timeframe, however, we'd still have those mortgages to worry about too.

Is it worth paying down those mortgages, then saving for a big deposit in 7 years time or will we be too old for mortgages then? Also, we were planning to start some other kind of retirement fund at that point too. Neither of us get a workplace pension, so could do with some advice there too...

Sorry this is really long but I'm not sure what the best approach is to do... any help would be greatly appreciated.

Thanks

CLAPTON

debt-freeoneday wrote: »

Hi there

I hope I've posted this in the right forum, apologies if not. I'm looking for some advice...

I'm 34 years old, husband is 37. We made some pretty big financial mistakes earlier in life and ended up in a debt management plan. Just about to come out of that having almost paid off £41K in credit card and loan debt in the last two years.

We're now looking to the future and wondering what to do next. As yet, we have no retirement savings, but we do have two rental properties, each with mortgages on which we had from before our debt management plan.

Property 1: Mortgage amount £132K interest only - property value estimate £135K (was worth £150 a few years ago before the decline in the market). Rent covers interest only mortgage but not repayment.

Property 2: Mortgage amount £34K repayment - property value £60K. Rent covers mortgage with £200 to spare.

These properties bring in a combined income of £1100 per month. Obviously we pay landlord insurance and there are other repair and maintenance costs that we sort out.

It's our intention that these properties form part of our retirement fund in the future, once they are paid off.

We're thinking about aggressively paying down these mortgages soon with a view to having them both paid off in 6-7 years, which we think is doable. If we were to pay them off, we'd benefit from the additional income well before retirement.

However, we don't own our own home that we live in and this is the sticking point. We currently rent and because of the DMP, we'd struggle to get another mortgage anyway for the next few years. Also, I'm self employed and don't earn all that much on paper, hubby is a director of his own company but takes a low salary because of money being reinvested in the company.

If we were to get a mortgage to buy our own home, we'd have to save a huge deposit within the same kind of timeframe, however, we'd still have those mortgages to worry about too.

Is it worth paying down those mortgages, then saving for a big deposit in 7 years time or will we be too old for mortgages then? Also, we were planning to start some other kind of retirement fund at that point too. Neither of us get a workplace pension, so could do with some advice there too...

Sorry this is really long but I'm not sure what the best approach is to do... any help would be greatly appreciated.

Thanks

what sort of interest rate are you paying on the mortgages?

debt-freeoneday

Hi there

We're paying 4.5% on the £132K mortgage and I think it's 4.1% on the other. We were on fixed deals with both mortgages which have since ran out, however we can't remortgage due to the impact the DMP has had on our credit rating...

The only plus side is that there is no penalty for overpaying.

jimjames

Personally I wouldn't pay them down. Save elsewhere and pay them off once full sum is saved. Maybe use s&s ISA if you have 7 years or more and are prepared for some risk.

If not then I'd save separately so you don't lose the tax benefits of the mortgage but might be worth checking calcs on breakeven point for rate vs savings.

If no pensions then that should be a priority too I think

debt-freeoneday

Thanks JimJames, appreciate your advice.

I understand your point about not affecting any tax breaks, my only worry about saving elsewhere and then paying off when I have the full amount, is just about the interest I'd be paying on the mortgages whilst saving elsewhere I guess...

bowlhead99

The mortgage interest you are paying acts as a tax shield, because if you didn't need to pay the (say) £5000 a year of interest, your property rentals business would make £5000 more profit, and then you would be paying 20% or 40% tax on that profit and would only make a net amount after tax of £4000 or £3000 extra profit.

So, every pound that you choose to use to pay down the mortgage might save you 4p of interest each year, but it doesn't make you 4p better off each year because you are now paying more tax - it only makes you 3.2p better off if you're basic rate tax or 2.4p better off if you're higher rate tax.

Meanwhile every pound you put into a S&S ISA might reasonably be expected to generate 5p+ of investment income and gains, tax free, over the long term.

Same with every pound you put into a pension, it is even better because of further tax breaks, but if your financial condition is still kinda shaky, probably best not to overstuff your pension at this point. The negative for contributing to pensions is that the money gets locked up for a time and you can't get it back until you're 55. Given one of your mortgages is barely being covered by rental income, and could go up with interest rates, or the income could go down with empty periods or a real problem tenant on one of the properties, it would be incredibly frustrating to have contributed too much into a pension and not have cashflow and need to go straight back in a DMP!

Looking at the fact that one of your mortgages is at a high LTV, you might think you should really try to clear it down ASAP. However, the rental property has a problem in that it isn't making you any more money than you need to spend on the mortgage interest and so no buffer is building up for repairs and maintenance and to cover void periods etc, and even the other property is only clearing £200 a month (after expenses and taxes?). If you don't have cash on hand to cover the expenses during a month with reduced income (whether this is due to a problem with the tenants, or your personal business, or husband's business) you could get into trouble. You need a substantial stash of cash to act as a rainy day fund.

If you pay a whole load of extra cash into your 132k mortgage and clear it down by, say, 20k, to 112k, you are still above 80% LTV on the property. So if something comes up (even just a problem tenant not paying the rent on time, let alone something more extreme like needing £5k for a boiler or £10k for a renovation after a tenant trashes the place by more than his security deposit), it would be difficult or impossible to get the 20k back to cover this expense, help you get through your other day-to-day expenses or even meet the mortgage interest payment for that month. With your credit you'd struggle to borrow 10-20k in a hurry or remortgage when your rental property is already over 80% leveraged and doesn't make much profit each month and you don't own your own home or have your own salaried income.

But long story short, I'm with Jimjames that I wouldn't be keen to overpay the mortgages just yet if the interest rate is 'only' 4% ish (2-3% ish after tax). You mentioned you can pay the mortgages off without penalty. So if the mortgage rates go up on you or you decide in the future that your savings are now adequate to cover the risks to which your property rental and other businesses are subject, you can simply pay a big chunk of the mortgage off later.

Instead, for now, try to build up a separate nest egg and then you can take stock of how it's going at a later point; refinance then, or indulge in other options (getting a residential mortgage, improving pension situation, paying off the BTL mortgages or whatever). Sounds like if you have paid off £40k of debts in the last couple of years and were considering clearing your £160k of mortgages in the next 6-7 years, you are able to create 20-25k of new savings every year so a very much more stable and improved personal situation is not too far away.

The absolute most money-saving solution may technically be to clear down some of those mortgages, because if you decide S&S ISAs are not appropriate you probably can't earn savings interest net of tax at the 2.4-3.2% level that you'd gain from paying off the mortgage. But what you are buying by putting money aside away from the mortgage, is flexibility. You are de-risking your life by creating options. Having a lower LTV sounds like a no-brainer if you don't evaluate it fully. But having a slightly better LTV that is still not low enough to access a better interest rate on the whole mortgage and which doesn't allow you to recover the cash by remortgaging later, and has stopped you having an emergency fund, leading you to need credit cards and loans later because you can only save £2k a month and you need £5k to spend on one of the rental properties or lose income from it... doesn't sound so great.

Life is about balance so by all means pay off some of the mortgage but consider getting that fat stash of cash savings or other investments and/or a retirement plan first, before you think of paying a low interest long term debt that is already being serviced adequately (or certainly could be if you had a huge cash stash on the side).

Spidernick

I think JimJames is saying you could get a better return than 4.5% if you invest in a stocks & shares ISA for seven years. You wouldn't get that in interesting-bearing accounts, unless you could open a number of Santander accounts with their 5% up to £20K and that takes a bit of work from what I've read.

The other point, as highlighted above, is that the interest you are paying is tax deductible for the purposes of your rental income, so as the capital reduces, so does the interest, meaning the profit on which you pay tax will increase over time, so this can be seen as counter productive. Saying that, as rates rise your profit would then go down and you may therefore feel it is better to reduce the level of the mortgage to counter this.

Personally, I don't like debt and like seeing my mortgage going down, even though I could do better by saving the money (albeit that it then tends to get spent when I've done this!). At the end of the day, I'd say to do whatever you feel most comfortable with.

A pension is a must, as also mentioned above, even if you would like rental income to act as a pension to a certain extent (as you'll always have those unexpected bills at awkward times with a rental property, which might be more inconvenient if your main source of income in the future).

I don't suppose either of the properties is close to where you want to live? If so, then the obvious option would be to move in there.

debt-freeoneday

Thank you so much for your detailed replies which have really helped me to understand and weigh up the tax side of things.

Yes, I see what you mean about creating that 'flexibility' by saving elsewhere just in case. All I could think about was the interest we're paying and how much I hate debt, but actually, because our situation is still vulnerable, it's well worth considering the risks that are most definitely present such as a major rental repair. As yet, we've just had standard maintenance costs to contend with, but I guess one day, we'll be hit with a major piece of work that needs doing.

I really do think that we'll be able to save a significant amount in the next few years, through living like we have been doing (on an extreme budget) and banking any spare money we have. I will consider a S&S ISA thank you to everyone who mentioned that.

Re the pension, can anyone recommend a good one that will is relatively low risk? Or should I be going for medium risk?

Spidernick - both properties are where I used to live - one was my former family home which I bought from my parents, the other was the home I shared with my hubby before we relocated to be closer to his business...! So we can't really move back anytime soon.

atush

Personally, I dot think it is wise to own a property you dont live in, that doesn't turn a profit. So sell that one, or better yet move into it. Then your mtg outlay is the same, but you are saving the rent money.

With the rent money, i'd save an emergency cash buffer. Then, do your employers offer a pension? How much do they pay in? I'd join those. After all, every 80 you out into a pension becomes 100 immediately. Add in a matching employers contribution and you could double your money.

then, if you have extra cash, you could look at paying down the 132K mtg or better yet, refinance as a repayment but not BTL (so rate could be lower). If your credit does not allow this, save into a S&S isa until it does.

debt-freeoneday

Thanks atush for your reply, sadly we can't move back in as both properties are 80 miles away from where my husband's business is based. I'm self employed and my husband is a director of his own company so we don't have workplace pensions.

I'm definitely considering a S&S isa now and we are able to switch to repayment (we're on a consent to let, not buy to let) without having to apply for a new mortgage, so we could potentially do that.

aggypanthus

atush wrote: »

Personally, I dot think it is wise to own a property you dont live in, that doesn't turn a profit. So sell that one, or better yet move into it. Then your mtg outlay is the same, but you are saving the rent money.

With the rent money, i'd save an emergency cash buffer. Then, do your employers offer a pension? How much do they pay in? I'd join those. After all, every 80 you out into a pension becomes 100 immediately. Add in a matching employers contribution and you could double your money.

then, if you have extra cash, you could look at paying down the 132K mtg or better yet, refinance as a repayment but not BTL (so rate could be lower). If your credit does not allow this, save into a S&S isa until it does.

May I ask, isn't it worth having a rental property with little profit, just to benefit from the eventual sale ofit at the end of its term. ?