The Budget’s mortgage interest relief changes and buy-to-let explained?

The Budget’s mortgage interest relief changes and buy-to-let explained?

Strong investment criteria, rather than tax breaks will ensure the buy-to-let success story continues.

When George Osborne sat back on the famous green benches of the House of Commons after giving his second Budget speech in four mouths, one subject was on the minds of buy-to-let investors – mortgage interest relief.

The Chancellor said the tax relief on rented homes will be cut from 40% or 45% to basic rate, which is currently 20%.

Here’s what it means to a buy-to-let finance market than now accounts for 15% of overall UK mortgages:

What is mortgage interest relief for buy-to-let investors?

Tax has always been charged on income received from rental properties. This is calculated after allowable expenses are deducted. Major areas landlords are eligible for tax relief include:

  • Rental insurance
  • Any maintenance of the property
  • Letting agency fees
  • 10% of annual NET rental income to cover depreciation of furnishings

And crucially:

  • Interest on a buy-to-let mortgage

This meant that if you have an interest-only mortgage, your whole monthly repayment will be tax deductible.

This allowed buy-to-let landlords to offset their mortgage interest payments against their income, whereas homeowners who live in their properties cannot.

The Budget document states:

“The current tax system supports landlords over and above ordinary homeowners. Landlords can deduct costs they incur when calculating the tax they pay on their rental income. A large portion of those costs are interest payments on the mortgage.

“Mortgage Interest Relief was withdrawn from homeowners 15 years ago. However, landlords still receive the relief.

“The ability to deduct these costs puts investing in a rental property at an advantage. Tax relief for finance costs is particularly beneficial for wealthier landlords with larger incomes, as every £1 of finance cost they incur allows them to pay 40p or 45p less tax.”

Why will this be controversial?

A Freedom of Information request recently revealed this tax relief accounts for £6.3 billion a year, while making it easier for investors to purchase a house than it is for people to get on the housing ladder.

Conversely, landlords counter that they provide much-needed rental accommodation – the UK’s PRS has doubled in size over the past decade – and paying tax on mortgage interest would override the basic principle of only taxing profit not overall turnover.

When will the changes occur?

The measure will be phased in “gradually” from 2017. Currently interest payments of £100 cost £55 after tax relief, but will cost £80 from 2020.

How will the buy-to-let market react?

Key points:

  • Buy-to-let will still be attractive to investors. Property is an asset offering high levels of diversification and has a track record of capital growth that outpace inflation.
  • Many investors will be largely unaffected, in particular those investing capital without mortgage finance
  • Landlords relying solely on the tax breaks rather than high yields may be forced out of the market
  • Landlords could seek to recoup margin by increasing rent levels more quickly

As mentioned, property will remain an investment staple. Bricks and mortar offers a different alternative to equity-heavy portfolios and its long-term appeal will not be diminished.

A large portion of investors use cash savings for purchasing and will be totally unaffected by the changes, it is only the buy-to-let mortgage submarket that may need to be re-evaluated. As helpful as the tax breaks have been, the reality is that strong supply and demand criteria creating the potential for strong returns should dictate property investment not a fiscal loophole – and this remains the case after the Budget announcement.

The Chancellor explained buy-to-let has been a massive success story and it will continue to be so for most investors after the Budget, pointing out that specialist lenders are committed to the market and it will continue to expand.

Some landlords making marginal gains may leave the market. This could squeezed the availability of rented houses even more than it is already, pushing yields even higher for landlords and investors still in the market.

Who is saying what about the buy-to-let changes?

Paul Emery, a tax partner at PwC, said:

“Clearly this is going to make landlords put up rents and does nothing to resolve the bigger issues of a lack of housing supply and credit availability which is creeping up.”

Genevieve Moore, a partner at chartered accountants Blick Rothenberg, said:

“This is likely to impact many of Britain’s workers who have saved hard and invested in property to supplement their retirement. [We] could see a flood of buy-to-lets being sold as the squeezed middle bow out of the rental market.”

Gráinne Gilmore, Head of UK residential research at Knight Frank, said:

“Those planning to purchase a buy to let property will have to factor these new rules into their calculations, and this could affect the offers they are willing to make.

“If the relatively low yield environment seen today, especially in the South of England, is still evident when these changes start to come into force, there could be upward pressure on rents. The need for rental accommodation is strong, and we expect this trend to continue, especially in city centre markets around the UK.”

Peter Williams, Executive Director of the Independent Mortgage Lenders Association, said the idea that tax benefits have been a big driver for growth in the private rental sector is not the complete picture.

“Unlike home owners, private landlords are still subject both to capital gains tax and tax on rental income, subject to allowable deductions for most costs. It also overlooks the fact that two in three properties entering the private rental sector since 2007 have done so without the support of buy-to-let mortgages.”

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