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Bargain B2L mortgage rates are a generous corrective to tax relief deductions
August 7, 2018Article by Paul Avery
You may have heard that they heyday of buy-to-let investment is behind us, with margins now sinking in the wake of the tapering of mortgage interest tax relief and the volley of other measures introduced by the last Chancellor.
In fact, buy-to-let remains as profitable as ever: interest rates remain extremely low (despite last week’s marginal bank rate raise), previously-dormant regional markets are coming to life, and, as in any other model of supply and demand, the more landlords exit the game the better the conditions for those who do not.
This post will explore the impact of the present interest rate environment on buy-to-let investment. This is a key point that often gets forgotten in the admittedly vexing debate around the gradual reduction of tax relief for landlords.
What has changed?
To refresh: prior to April 2017 landlords could deduct all mortgage interest payments from their taxable income. After that date only 75% of the value of those payments was tax deductible, dropping to 50% in 2018, 25% in 2019, and finally to 20% from April 2020 onwards.
Landlords in high tax brackets with multiple properties financed at high loan-to-value ratios anticipate trouble, while basic rate taxpayers with smaller portfolios may not notice.
There is no question that this measure is bad news for the buy-to-let sector. However, the level of tax relief on mortgage interest is fundamentally less important than the actual interest rate available – and that has improved considerably over the last couple of years.
So, in effect, current conditions are far more favourable for new investors and those with variable rate mortgages.
How does this affect the numbers?
To quantify the differences, below are some worked examples that compare the situation for both low and high tax payers in 2012 (when mortgage interest was tax deductible but rates were high) with low and high tax payers in 2020 (when interest will only be deductible at the ongoing level of 20% but interest rates, if locked in today for a 3- or 5-year term, are much lower).
The tables below make the following assumptions:
– A hypothetical property costing £100,000, financed at 75% LTV and yielding 7.5% gross
– Allowable costs of £1,000 such as a ground rent and service charge – which are tax deductible
– Comparing the mid-2012 average fixed-rate, interest only buy-to-let mortgage of 5.09% (This Is Money) with a middle-of-the-road 5-year rate of 2.39% currently available with the Post Office (MoneyFacts)
– The yield for the 2020 scenarios also reflects the 3% stamp duty surcharge introduced in April 2016, which is added here to the purchase price
It is clear that today’s interest rates, even with the full reduction in tax relief and additional stamp duty that will apply in a few years’ time, allow leveraged investors to do far better than they did in 2012. For basic rate tax payers, incomes are 76% higher, and for top rate tax payers, they are 53% higher.
If we expect interest rates to remain low or climb back slowly, then present conditions offer a really strong buying opportunity despite the regulatory bad news. The average buy-to-let interest rate must rise to 5% in order for basic rate payer yields to fall below those of 2012, and it must rise to 3.7% for top rate payer yields to do so.
On a side note, these numbers also point to the increasing usefulness of investing in property through a limited company. This allows even high rate tax payers to access the highest returns of the four scenarios, since mortgage interest remains completely deductible for companies (in addition to a wealth of other benefits, which we have explained elsewhere in this blog).