Planning next move... Pay off current mortgage and use house as collateral?

CrossedtheRubicon

Hi everyone, I’m new here so apologies if this sort of thing has been covered before! I’d be really interested in your thoughts/advice if possible...

I run a small media marketing business which has done fairly well, I bought a small three bed terrace house nine years ago for £160k (now worth approx £230k) and have £80k left on the mortgage. I’m also fortunate enough to now have £230k in savings. Im now in my early thirties and my wife is pregnant with our first child so we’re looking to make a move to a bigger family house. Our fixed rate mortgage period is up in June and then moves to quite a high variable rate. My plan is to pay off our mortgage in full in June, then once the baby is born we will buy our family house in March/April next year. 

Rather than sell our current house I’m planning to rent it out (due to location we could easily get £800-£900 pm), and buy a second home for us to live in with a budget of around £400k-£420k. If the bank had an issue with the LTV I would have no problem offering up the mortgage-free rental house as collateral.

Do you see any major issues with this plan? The business itself continues to be strong, has very low overheads and is positioned to do well enough in the coming downturn. We would likely have a good rental income (houses rent very quickly in our area) and my wife was a teacher so she can get a job in a year or two if money ever becomes tight. Obviously the coronavirus means everything is up in the air, but hopefully by the time we are planning to move we should have a better idea of what’s happening with the housing market/rentals etc and can adjust plans accordingly. I’d be really interested to get your thoughts/ideas if possible, or even what you’d do in my position... We will talk to a financial advisor before setting anything in stone, but the lockdown prevents that for the time being! 

greatcrested

Don't forget 2nd home 3% additional SDLT.

Do you want to run letting business?

Now here's some background reading for you:

greatcrested

New landlords (1):advice & information :see links in next post

Thanks to tbs624

Before letting a property, get a good book (below), take a course, & read the following (Applies in England/Wales):

SEE LINKS AT THE END OF THIS POST.

Research
Learn the legal obligations, & tenant's rights. See Shelter's website below. Even if using an agent, learn the basics of Landlord & Tenant law, deposit registration, inventory management, repairing obligations, notice & eviction processes. Understand the difference between Fixed Term and Periodic tenancies. Ultimately you are responsible, not the agent.

Do a detailed budget (spreadsheet). Include all costs. Base income on 10 months a year to allow for voids, & tenants who default: a) initial set-up b) routine annual c) tenant-change-over costs. Budget d) repairs & overheads - predictable and unpredictable (eg new boiler). Add agency fees, landlords insurance, tax etc. Estimate postage, phone, petrol, documentation etc. Have contingency fund for worst-case 'tenants from hell' where you have to pay a mortgage for 8 months without rent, then pay to repair damage. Read a good book.

Permissions
You'll need
* Consent To Let from your Mortgage Lender unless you have a Buy To Let mortgage (CTL/BTL).
* Consent from your Freeholder if you have a lease (ie a flat and some houses).
* Specialist landlords insurance. Normal domestic insurance is invalid if you let the property. Compare risks as well as premiums.
* in Wales, some English councils (& Scotland) you must be registered & maybe licenced (here).

Safety & the Law
Since 1/10/15, new tenants must receive the 'Prescribed Information':
* government leaflet "how to rent"
* EPC (min E rating)
* Gas Safety Certificate if there's gas
* Smoke detectors on each floor
* CO alarm if there's solid fuel heating.

* From 1/2/16 landlords must check tenants' immigration status.

* furniture - certified fire-resistant
* electrics & electrical appliances - safe.
* Security deposit - registered & 'Prescribed Information' provided within 30 days of receipt. Failure has serious consequences. Never rely 100% on an agent.
* HMOs - special rules: check local council.

Documentation
* A good tenancy agreement. Consider the OFT's unfair contract terms guidelines
* check-in inventory should be comprehensive. Use inventory clerk? Otherwise, deposit deductions will be hard to justify
* holding deposit - refundable?
* application & vetting forms. Authorisation for credit searches
* standing Order mandate for rent payment
* letters to utilities for account hand-over
* security deposit scheme application. It's the law
* tenant info folder: boiler/appliance instructions, alarm system; how to replace smoke/CO alarm batteries; location of stopcock/fusebox etc; rubbish arrangements, emergency contact no.s for repairs; colour/brand of emulsion to touch up paintwork; current utility suppliers (+ ask the T to let you know if they switch); local doctor etc

Management
Be cautious appointing a letting agent. The right agent is as important as the right tenant. Check their credentials & get recommendations/references. Check your contract with them. Can you get rid if they're no good? See link below.

Take tenant vetting seriously, either DIY or use an agent. Check ID, references, income, credit history, immigration status etc & take nothing for granted (reference the LL before the current one - he may be keen to move them on). Consider a guarantor for high risk tenants, or if you can't vet (overseas applicants, first-time renters etc). Remember a Guarantor Agreement must be Executed as a Deed/witnessed, & guarantor given the tenancy agreement in advance - many agents get this wrong.

Don't let your agent force you to renew Fixed Term contracts if a Periodic Tenancy will suit. Agents recommend new Fixed Terms as they charge fees from both sides, but a Periodic Tenancy arises automatically. See link below.

Consider carefully whether & when to increase rent. A long-term tenant is far better than a nominal rent increase. See link below.

Consider maintenance/repairs: Use your own handyman/contractor when needed, DIY, or leave it to your agent who will have contractors.... at a price.

Decide how often to inspect (be reasonable) and include in the tenancy agreement.

Tax
You're running a business, even if it's a short term arrangement or rental to family, so you have to declare rental income whether tax is payable or not. Research the Income Tax liability and allowances before you start. Note only the interest element of your mortgage repayments is tax-deductable (see below). Consider Capital Gains Tax. If going abroad, & you have no agent, read the Non Resident Landlord Scheme - see below.

Support and advice
Join a Landlord's Association and/or a web-based source (see below). Membership fees are tax deductible, & offer discounts on insurance, documents, vetting services, training and more. Some areas have local associations affiliated to one of the nationals. Check your local Council for accreditation scheme for private LLs.

Rent Guarantee Schemes
Some Housing Associations, councils, and private letting agencies offer schemes which guarantee your monthly rental income, removing the risk of costly voids between tenants. The advantage of these schemes is obviously the certainty of regular income to pay your mortgage etc. Against this you must weigh 1) the (significantly?) lower rent you will receive; 2) the removal of your freedom to select either the specific tenant or even the type of tenant; 3) the reality that the HA/agent etc will have little concern for the protection/condition of your property; 4) the reality that their priority will be to have a tenant (any tenant) in occupation. Additionally you should ensure that your landlords insurance/mortgage terms do not prohibit the type of tenant the HA/agent plans to install.

Additionally, be aware your contract will be a commercial tenancy, not an AST (Assured Shorthold Tenancy). This has significant legal ramifications (eg S21, S8, S13 Notices don't apply).

General Advice
Remember although it may have been your home, you will be handing over "exclusive occupancy" of the property, and tenants are entitled to view it as their home, without undue interference ("quiet enjoyment"). Make sure you understand the limit of your rights (ie access - a dodgy clause in your tenancy agreement does not grant you free access)

Be business-like but fair, most tenants respond in kind, looking after your property and keeping those expensive voids at bay.

And be careful letting to friends or family - will you be willing to evict if you have to? Are you concerned about losing their friendship or love?

OK - now visit the post below (New landlords (2) )for the promised links to all the research you need to do before taking the plunge!

greatcrested

New landlords (2): Essential links for further information

If you are a new landlord, or taking over management from your letting agent, the links below support the guidance in the previous post (New landlords (1)). This includes links to the relevant leglislation and regulations, as well as to other websites providing guidance and information.

Books - Try your library. (Check publication date as laws change):
The Complete Guide to Residential Letting 2015 (also available here)

Successful Property Letting 2017: (How to Make Money in Buy-to-Let)

Landlordzone (Landlord information + forum)

Landlord Law (Property solicitor!!!8217;s website - clinic, blog, resources, advice etc) + Landlaw Law links (more links for landlords)

Shelter England (Tenants' rights) Shelter Scotland

Shelter (Repairs in private rented homes)

Gov advice (Renting out your home: government website)

HMRC (Property taxes eg Income Tax on rent (and allowable expenses to offset tax); Capital Gains Tax, etc)

HMRC (Non Resident [= overseas] Landlord Scheme)

Deposits (Payment, protection and return)

Deposits (Gov site: rules on deposit protection)

Prescribed Information (RLA links to various deposit schemes' documentation)

HSE (Gas Safety Certificate rules)

EPC (Energy Performance Certificate rules)

How to rent (mandatory government leaflet)

ESC (Electrical Safety Council - Rules)

The Smoke and Carbon Monoxide Alarm (England) Regulations 2015 (from 1/10/15)

Right to Rent (Mandatory checks on tenants' immigration status)

RLA (Residential Landlord!!!8217;s Association - mixed reviews)

NLA (National Landlord!!!8217;s Association)

Letting Agents (Tips for selecting, and tips for sacking them)

Letting agents (Landlordzone guide)

ARLA (Letting agents' professional body)

The AIIC (Association of Independant Inventory Clerks)

ParagonAdvance (Tenant referencing provider !!!8211; there are others. Use Google) Letsure

Landlord & Tenant Act 1985 (Repairing obligations; LL's address; and much more)

Landlord and Tenant Act 1987 (Address for Notices; etc)

Protection from Eviction Act 1977 (speaks for itself really. Also makes harrasment a criminal offence)

Housing Act 1988 (Definitions and rights of various tenancy catagories - note AST is most common; creates Statutory Periodic Tenancies)

Housing Act 2004 (Deposits; Houses of Multiple Occupation; etc)

Localism Act 2011 (section 184 - updates to deposit scheme rules)

Deregulation Act 2015 (amendments to deposit penalties & S21 service, smoke alarms, retaliatory eviction rules)

Statutory Instrument 2015 No. 1646 (Prescribed Information at start of tenancies from 1/10/15 - Deregulation Act)

Requirements for new tenancies since Oct 2015 (Stat Inst 1646 & Dereg Act)

Tenant Fees Act 2019 Abolition of most tenant fees from June 1st 2019 Gov Guidance Notes

Shelter information on 2019 restrictions on tenant fees.

Written demands (for rent etc: LL's actual address needed) Beitov Properties Ltd v Martin

Rent Increases (how and when can rent be changed)

HMOs (Licencing of Houses in Multiple Occupation in England: A guide for landlords and managers)

OFT356 (Unfair Terms in Tenancy Agreements)

Housing (Wales) Act 2014 (landlord registration & licencing)

This advice is not exhaustive. Whole books are devoted to the subject.

CrossedtheRubicon

This is all incredibly useful - thank you very much greatcrested. I shall have a good read.

Yes, I’ve planned for the additional SDLT, and I have no issues becoming a landlord and the extra time/responsibility that involves. I’m interested in hearing if that sounds like a good strategy, or whether I’ve completely overlooked something that might be a major consideration?

eddddy

CrossedtheRubicon said:

If the bank had an issue with the LTV I would have no problem offering up the mortgage-free rental house as collateral.

I've never heard of a high street mortgage lender that accepts a second property as collateral.

More likely, you'd have to get a BTL mortgage on the first property and a residential mortgage on the second property. Subject to the each lender's affordability and acceptance rules.

[Deleted User]

The gross rental yield is less than 5% on the rental property, assuming you get £900 pcm and have no voids.  How long will it take your rental property business to break even after paying the extra £12,600 in SDLT?  What other investments do you currently have?

Mortgage wise I think you'll be looking at a Let to Buy mortgage where you release some of the equity in your current home and use it to help fund the next purchase.  Previously the maximum LTV was 75% but I have no idea what the LTB situation is due to the pandemic.  I know that many lenders of regular residential mortgages are looking at a maximum LTV of 40% now.

CrossedtheRubicon

eddddy said:

CrossedtheRubicon said:

If the bank had an issue with the LTV I would have no problem offering up the mortgage-free rental house as collateral.

I've never heard of a high street mortgage lender that accepts a second property as collateral.

More likely, you'd have to get a BTL mortgage on the first property and a residential mortgage on the second property. Subject to the each lender's affordability and acceptance rules.

Thanks for your thoughts eddddy,

Yes, I was wondering if that would be possible... We’d have around £150k to use as the deposit for our move if we kept our current property and paid off the mortgage. So possibly it might not be needed as collateral (if they even accepted it) depending on the value of the residential mortgage we applied for.  

I suppose it all rests on whether we can get a mortgage agreed in principal with our deposit and earnings etc. As a small company director I imagine lending rules are likely to tighten in the coming months.

CrossedtheRubicon

Lover_of_Lycra said:

The gross rental yield is less than 5% on the rental property, assuming you get £900 pcm and have no voids.  How long will it take your rental property business to break even after paying the extra £12,600 in SDLT?  What other investments do you currently have?

Mortgage wise I think you'll be looking at a Let to Buy mortgage where you release some of the equity in your current home and use it to help fund the next purchase.  Previously the maximum LTV was 75% but I have no idea what the LTB situation is due to the pandemic.  I know that many lenders of regular residential mortgages are looking at a maximum LTV of 40% now.

Many thanks Lover_of_Lycra,

We have no investments other than ISAs and a few savings accounts that offer 1.7%ish interest. I’ve been so focused on running the company, that we’ve essentially just saved our cash with the idea that we’d look into what to do with it later... Probably not the best move financially but it’s allowed me to focus my efforts on growing the business. 

I estimate it would be roughly two years to pay off any SDLT depending on voids etc. But after that (all going well) it should be a pretty regular source of income with no mortgage to worry about.

Yes, it’s all very dependent on how things play out over the next few months with the economy. We’re not looking to move until about this time next year so fingers crossed things will be a lot clearer then!

AdrianC

CrossedtheRubicon said:

I bought a small three bed terrace house nine years ago for £160k (now worth approx £230k) and have £80k left on the mortgage. I’m also fortunate enough to now have £230k in savings.

Rather than sell our current house I’m planning to rent it out (due to location we could easily get £800-£900 pm), and buy a second home for us to live in with a budget of around £400k-£420k. If the bank had an issue with the LTV I would have no problem offering up the mortgage-free rental house as collateral. 

You're overthinking it...

Pay off mortgage on current property = £150k savings remaining.
Buy new home = £30k for fees and SDLT (£23,600 for £420k additional property), £120k equity, £280-300k mortgage. No way are they going to have an issue with ~70% LtV. As you say, if there's an issue, it'd be because of mortgage affordability.

Now, have you actually done the sums on whether this lettings business makes any sense? I'm not talking about the emotional baggage of "That's our old home...", but is this the RIGHT property? £800/mo is only 4% yield on a £230k property. Take off all the costs etc, and pay tax on the income. Let's say £500/mo net. At that rate, it's going to take over two years just to cover the additional property SDLT, before you see one single penny in your pocket.

It'd probably make far more sense to chain the sale and purchase, then - if you REALLY want a lettings business - buy a place specifically for it, and pay the 3% on that.

[Deleted User]

CrossedtheRubicon said:

Lover_of_Lycra said:

The gross rental yield is less than 5% on the rental property, assuming you get £900 pcm and have no voids.  How long will it take your rental property business to break even after paying the extra £12,600 in SDLT?  What other investments do you currently have?

Mortgage wise I think you'll be looking at a Let to Buy mortgage where you release some of the equity in your current home and use it to help fund the next purchase.  Previously the maximum LTV was 75% but I have no idea what the LTB situation is due to the pandemic.  I know that many lenders of regular residential mortgages are looking at a maximum LTV of 40% now.

Many thanks Lover_of_Lycra,

We have no investments other than ISAs and a few savings accounts that offer 1.7%ish interest. I’ve been so focused on running the company, that we’ve essentially just saved our cash with the idea that we’d look into what to do with it later... Probably not the best move financially but it’s allowed me to focus my efforts on growing the business. 

I estimate it would be roughly two years to pay off any SDLT depending on voids etc. But after that (all going well) it should be a pretty regular source of income with no mortgage to worry about.

Yes, it’s all very dependent on how things play out over the next few months with the economy. We’re not looking to move until about this time next year so fingers crossed things will be a lot clearer then!

You will have a mortgage though because to release equity you will need to remortgage as a Let to Buy.

If you're speaking to a financial advisor ask them about pensions since it's appears you don't have one and they are very tax efficient, much more so than BTL.