Pay off mortgage or keep it to keep away the taxman?

boybeck

Hi all

I have £23,000 left on my mortgage which is due to be completely paid off in November 2011 without over paying. I'm on 5.75 per cent fixed rate for two years. I am overpaying £500 a month so it could be paid off in two years.

I will eventually rent out my house, should I be paying off the mortgage or would it be better to have it so I get interest relief on the rental profit?

What percentage of rental profit does the taxman take?

silvercar

The mortgage interest (but not capital) would be an allowable expense agains your rental income.

The quick answer is that any rental profit would be taxed at your marginal rate. The more detailed answer could talk about carrying forward any losses from previous years unearned income.

23,000 at 5.75% would be 110.21 a month interest only, so you wouldn't have to pay tax on that amount. At 40% that saves you 44.08 a month, so is costing you 110.21-44.08= 66.13. So if you put that 23,000 spare cash in an interest bearing account you would need to be earning at least 5.75% gross on it for it to be beneficial. I've gone round in a circle here to illustrate the point.

The bottom line is that if you can get a better gross rate on your money than the interest rate charged on your mortgage and your interest payments are lower than your rental income (so all the interest would be an allowable expense) it is better to keep the mortgage.

boybeck

Hi Silvercar

Thanks for taking the time to help, it's much appreciated.

So just to make sure I've got this right.

a) keep the mortgage to get tax relief on the rental profit (around £100 a month).

b) instead of overpaying £500 on the mortgage each month, put that money in a savings account giving higher than 5.75% interest gross.

boybeck

I have one more question.

Is it beneficial to put monthly overpayments for a mortgage into a savings account with a higher interest rate instead.. when you are starting from scratch in the savings.. i.e £0.

I can't quite get my head around it, when every month I'm paying £100 in interest on my mortgage. I'm not earning that in savings every month if the balance is starting at zero.

jessicamb

boybeck wrote: »

I have one more question.

Is it beneficial to put monthly overpayments for a mortgage into a savings account with a higher interest rate instead.. when you are starting from scratch in the savings.. i.e £0.

I can't quite get my head around it, when every month I'm paying £100 in interest on my mortgage. I'm not earning that in savings every month if the balance is starting at zero.

Because of the difference in the size of the capital base - earning 5% on £100 savings is a lot less than the interest cost at 5% on a £100,000 loan - very simplified but shows the idea I thnk

jamesd

boybeck, say you overpaid 500 in one month and no more. One year later you'd have saved 5.75% of that in mortgage interest, 28.75.

Put the same money in a tax free cash ISA at 6.3% and in one year you'd make 31.50 in interest.

So, saving in this case makes you 31.50 - 28.75 = 2.75 better off. Doesn't seem like a lot. Except say you do it for 300 a month for four years you end up better off by 189. It really starts to add up more over longer periods than yours. If you did it for 25 years the difference is 17,868 better off (and 129,000 interest earned on the savings).

However, it's the after tax savings interest that matters so if you are a basic rate tax payer you need to get 7.2% taxable interest to be better off. Some regular saver accounts do that. For higher rate, you need to be getting 9.6% taxable and not many accounts do that.

However, what's better than saving is investing. The long term average return from the UK large company market is about 12% and you get more stocks and shares allowance to use so you could save and invest all of your overpayments. I've written more on investing instead of repaying so you can see the potential.

To do a BTL and investing plan you'd release capital from your property up to the purchase price (the limit of the tax relief you can get) and invest it, starting with fixed interest investments and gradually shifting more to equities over the next few years so a drop in the stock markets doesn't catch you out at the start. But best to start with your overpayment money if you haven't invested before, so you can get familiar with it with relatively small amounts of money at stake. See Ok then - How do I choose a S&S ISA to get an idea of what a sector allocation is and the details of how to invest in funds via a stocks and shares ISA. It looks much harder than it really is until you've jumped in and started doing it.

boybeck

Hi Jamesd

I've already taken some tentative steps towards investments, I have just opened a stocks and shares ISA through Hargreaves Lansdown. The fund is Invesco Perpetual High Income. I'm going to put away a regular amount every month. From reading these forums I've come to the conclusion it's wise to invest as well as pay off.

I'll have a read of your articles.