Investment vehicle for capital only mortgage

mlp

I'm debating how best to pay off the capital of an interest only mortgage secured on a BTL basis, based on a 25 year mortgage period. A couple of options are:

Option 1:
Invest monthly into a Stocks & Shares ISA, do not pay down any mortgage capital. After 25 years, hopefully the capital in the ISA is more than enough to repay the mortgage capital (plus the house is owned outright and generating monthly rental income)

Option 2:
Use the same amount of cash that would have been invested in Option 1's S&S ISA to pay down mortgage capital. This probably leaves a fair amount of mortgage capital to be repaid after 25 years, although the interest paid is lower.

Now clearly a lot depends on what the mortgage interest rate does over the 25 years and what the S&S ISA returns are.

A third option could be to invest money in a pension rather than a S&S ISA and gain the tax relief on the payments in. In 25 years, I'll be 63 so would be able to access the pension pot, obviously paying tax on the withdrawal.

I am less keen on considering a pension as the investment vehicle as a future government could change the goal posts. At least with ISAs if the goal posts change the cash can be pulled out and invested in other ways.

Any thoughts? / rules of thumb?

Apodemus

I think the loan interest payments can be charged against the rental income for tax purposes, so you need to factor that into your equation if paying down the mortgage during its life is one of the options.

Personally, I would want to retain maximum flexibility to cope with changes to regulations, so would tend to agree with you on the pension option. Also life changes and you may want out sooner than you are currently planning.

jimjames

I'd use option 1.

It's also what I'm doing myself.

kangoora

I'd consider a bit of 1 & 3 (even though you didn't number option 3). You don't mention any other pensions so I'm assuming the BTL is your retirement plan? I don't think it's a case of only doing one or the other.

If you manage to get all your savings, apart from the BTL, into an ISA then you aren't making any use of your annual tax-free allowance from HMRC until you start to draw your state pension and hence not making any use of the tax relief available to you going into a pension. Also, each £100 you pay into a pension will only cost you £60 if HRT payer (or £80 if BRT payer).

If you contribute enough to a pension then you can withdraw a pension over 5 years (from 63 to 68) until it's empty, gaining the max benefit from the 25% tax free lump sum and your tax-free annual allowance. Work this right and you can effectively get circa £14k tax free p.a. for 5 years (assuming no other taxable income).

A pension has some other benefits also, it's not part of your estate for IHT purposes and it can't be touched in case of personal bankruptcy.

After 25 years you'd presumably have had a decent capital gain in the BTL but that would be taxed when you sold the house apart from that covered by your CGT limit.

Just some thoughts

ajdj

jimjames wrote: »

I'd use option 1.

It's also what I'm doing myself.

Same here, I'm building a low cost ETF portfolio using regular investment in a S&S ISA.

Linton

I dont like your "hopefully" - you need to be pretty certain. So I think it depends on how much your savings will be compared with the cost of repaying the mortgage. If the mortgage is only going to take a relatively small % of your total available wealth then go for option 1 as if things turned out badly, especially towards the end of the 25 years you could still pay off the mortgage.

If the future is less certain you could look at the opportunity to pay off mortgage debt early almost as the bond part of a balanced portfolio as it provides a guaranteed positive return. So if your investments soar put some of the savings (or even some of the profit) into repaying the mortgage, If new investments are cheap use your savings to buy more. This would mean that your investments could be higher risk than you would otherwise be comfortable with.

mlp

Thanks for the replies.

I actually already have a dormant personal pension pot with a current transfer value of ~£35k and am also in the LGPS which is now a career avg scheme.

I am a borderline higher-rate tax payer (the BTL income may push me into the band during this tax year)

The BTL mortgage is £120k, the property was valued for mortgage purposes at £190k.

kidmugsy

mlp wrote: »

I am a borderline higher-rate tax payer (the BTL income may push me into the band during this tax year)

Then use pension contributions at least to avoid higher rate tax.

Also, I suggest, consider Linton's idea of portfolio rebalancing. Once a year should be often enough to do a check. Just remember not to fidget.

mlp

Also, I suggest, consider Linton's idea of portfolio rebalancing. Once a year should be often enough to do a check. Just remember not to fidget.

Yes I think this is wise - especially as higher mortgage interest rates could change the whole perspective. Make hay while the sun shines as they say.

racing_blue

Lets assume you currently have a mortgage for £100K, a property worth £200K, and that's all.

Your "portfolio" would be worth £100K and the asset allocation would be 200% property, -100% bond (a mortgage being the inverse of a bond).

The end point of option 2 - repaying the mortgage - would be a portfolio worth £200K made up of 100% property.

The end point of option 1 - investing in shares - is the same. Because you are planning to use those investments to repay the mortgage. We don't know which route will be quickest, although history suggests investing in shares.

The interesting thing about option 1 is the flexibility it gives. Instead of repaying the borrowing in the future, you might decide to extend it buy another property. Or you might decide to sell the BTL and pay off the borrowing that way. Or you might simply carry on this leveraged investing in shares because you're The Man.

Thrugelmir

Will the BTL generate sufficient after tax income (i.e cash) to repay the capital debt?