With the recently introduced stamp duty tax on the purchase of additional residential properties, new restrictions on relief for finance cost, and now tighter affordability requirements on buy-to-let mortgages, the last two years have certainly been a roller coaster ride for residential landlords. Here we take a look at some of the most significant changes that have occurred and what you need to know if you’re looking for a buy-to-let mortgage in 2017.
The New Stamp Duty Surcharge
From 1 April 2016, anyone buying a buy to let or second UK residential property has been subject to a 3% stamp duty land tax (SDLT) surcharge. The new rates are applicable to both Individuals and companies buying a buy to let property or second home. The only instance in which you won’t be eligible to pay the extra 3% SDLT is if the property you’re buying is replacing your main residence.
For Example if you are buying a buy to let property or second home, you will now pay an additional surcharge of 3 per cent. The stamp duty is tiered (see below table), this means that you will pay a different stamp duty rate on different portions of the property value.
|Buy-to-let and second home Stamp Duty tax bands|
|Property Value||Standard rate||Buy-to-let/second home rate
|Up to £125,000||0%||3%|
|£125,001 – £250,000||2%||5%|
|£250,001 – £925,000||5%||8%|
|£925,001 – £1.5m||10%||13%|
How to calculate Stamp Duty?
If you bought your first buy to let property after 1 April 2016 for £500,000, you would pay 3% on the first £125,000, 5% on the second £1250,000 ( £250,000- £125,000 ), then a further 8% on the remaining £250,000.
£125,000 * 3% = £3750
£125,000 * 5% = £6250
£250,000 * 8% = £20,000
Total = 30,000
Click here to use our buy to let stamp duty calculator so that you can work out the stamp duty on your second home or buy to let property.
Changes to Mortgage Interest Relief
Before we delve into this deeper, let’s take a quick look at what mortgage interest relief is and how it works.
Imagine you are a buy to let landlord and your annual rental income is £20,000. You pay £10,000 interest cost on your buy to let mortgages. So the profit you make is the difference between your rental income and interest cost which in this case is £10,000
If you are a basic rate tax payer, you would pay 20% tax on £10,000, which is £2000 and keep £8000. If you are in a 40% tax bracket, you would pay £4000 and retain £6000 or pay £4500 for a taxpayer at the 45% additional rate, leaving £5500
Once the new measures are fully effective, which is from April 2020, you will no longer be allowed to deduct mortgage interest costs or any other financing cost from your taxable profits.
A simple arithmetic example is as follows:
|Mortgage Interest Cost||5,000||5,000|
|Basic Rate Tax Payer (20%)||800||800|
|Higher Rate Tax Payer (40%)||1600||2,600|
Click here to download our Mortgage Interest Relief Changes Calculator and see how these changes may impact your tax liability.
Let’s look into this in further detail.
Before April 2017
At the moment, residential property landlords are entitled to offset various costs associated with their buy to let mortgages as an expense against the rental income. For those who are thinking of becoming a first time residential property landlord by taking out a buy to let mortgage, you should know that landlords are entitled to receive tax relief on mortgage interest payments and other associated financing costs. These include interest paid on servicing the mortgage and any additional costs of securing or repaying finance, for example an arrangement fee or exit fee. Currently, Income Tax relief is available at marginal rate of 20%, 40% or 45%. So higher rate tax paying landlords can claim tax relief at 40 per cent and additional rate taxpayers at 45 per cent.
From April 2017
Tax relief on buy to let mortgage interest which was available to property landlords will be restricted to only cover the basic rate of income tax. As a residential landlord, if you’re subject to income tax, you will have new restrictions applied to the relief you receive on the finance costs of running your rental business. This will include both interest paid on any debt, as well as the costs of securing or repaying your buy to let mortgage. These restrictions will completely remove any finance costs from the tax calculation and introduce a basic rate tax credit, equal to 20% of the related mortgage costs.
It will be phased in from 6 April 2017 and fully implemented from 6 April 2020.
|Tax year||Percentage of finance costs deductible from rental income||Percentage of basic rate tax reduction|
|2017 to 2018||75%||25%|
|2018 to 2019||50%||50%|
|2019 to 2020||25%||75%|
|2020 to 2021||0%||100%|
From 6 April 2017, 25% of finance costs will be disallowed and subject to the basic rate tax credit. This will increase by 25% each tax year until the restriction applies to the total finance costs. Some landlords may see their tax bill increase by more than the difference between their marginal tax rate and the 20% tax credit.
Who is not likely to be affected under the new tax rules?
Those who pay basic-rate income tax or hold their properties using buy to let mortgages under limited companies, which are not affected by tax relief measures.
Is there any type of buy-to-let mortgage that would now be more tax efficient?
Yes, Limited Company Buy to Let Mortgages. Limited companies are not affected by this change because there is no restriction on deducting financing cost within the companies.
Options For Existing Buy to Let Owners
For existing buy to let investors who own properties in their personal names, one option is to change the ownership to a limited company mortgage. You must take specialist advise on this from a tax advisor as moving property from one ownership to another will typically incur stamp duty and capital gains charges. This is not applicable in all the cases because if you are running and managing your buy to let portfolio as a business, you might be able to move it to a limited company structure without paying any stamp duty or capital gains charges. We recommend that you always consult a tax adviser on this matter before proceeding.
New Buy to Let Investors
If you pay above basic rate income tax and are considering investing in a buy to property for the first time, you might be wise to consider maximising that investment through a limited company mortgage or a limited liability partnership.
If you are looking to refinance or invest through a buy to let limited company product, the Mortgaze team have access to wide range of limited company mortgages.
As a result of the recent changes, we do receive a lot of queries on limited company mortgages. Here is a little breakdown of some of the most frequently asked questions regarding buy to let mortgages for limited companies.
What is a limited company mortgage or limited company buy to let mortgage?
Limited company mortgages are not very different from traditional mortgages; the key difference is that you own your buy to let property through a limited company structure. In most cases, that limited company will be owned by you or along with your co-investors. Co-investors can be your spouse, business partner, or another family member.
I have an existing trading limited company, can I use that company to secure a limited company buy to let mortgage?
The majority of the lenders prefer and will only lend to what are known as SPVs (Special Purpose Vehicle). As the name suggests, an SPV company is formed specifically to invest in properties and is not used for any other trading business. There are a few lenders who might consider trading companies for buy to let mortgages but that will limit your options and you might end up paying a higher interest rate and arrangement fee. The majority of the applications we see for limited company buy to let mortgages are applied for through a SPV company.
Do you have buy to let limited company products for newly formed SPV companies with no accounts or previous history?
Yes, we do have access to a wide range of lenders who offer buy to let limited company products for newly formed SPV companies. Since there is no history attached to the company, from an underwriting point of view, the application will be assessed primarily based on the circumstances of shareholders and directors of the new SPV company. Of course the rental income from the buy to let property is one of the key factors in deciding the mortgage amount.
Is there any benefit in securing a buy to let property through a limited company mortgage?
There are two main advantages, compared to borrowing in your personal name, limited company mortgages are more tax efficient and are not subject to the tighter affordability checks which were recently introduced by the Prudential Regulatory Authority.
Are buy to let mortgages for limited companies more expensive?
In most of the case yes, but it all depends on the lender and your individual circumstances. The reason buy to let mortgages for limited companies are comparatively more expensive is because of the additional work which is involved in underwriting these mortgage applications.
What are the recent changes to the “Wear and Tear Allowance” for buy to let mortgage?
Another blow for buy-to-let landlords came when the chancellor recently announced an end to the “wear and tear” allowance. Investors could previously take off 10% from their annual rental income before calculating their tax bill, regardless of whether or not they had actually incurred any wear and tear costs.
From next April, however, the wear and tear repairs will only be deductible if they are actually carried out. Owners must also keep all receipts in case they are requested by the taxman.
To read the full list of frequently asked question on limited company mortgages, please click here.
New Affordability Requirements on Buy to Let Mortgages
On top of the recent mortgage interest relief changes, buy to let mortgages will now also be subject to new affordability requirements. These new affordability requirements on buy-to-let mortgages have been implemented by the Bank of England’s Prudential Regulation Authority.
Why have these changes been introduced?
The objective behind this decision was to ensure that mortgage firms conduct their buy to let business in a prudent manner and take into account the possibility of future interest rate increases as well as factoring in calculations of the running cost of the property. This has become more significant than ever given the recent changes to mortgage interest tax relief mentioned above.
How does it affect the loan amount I can secure on my buy to let mortgage?
The new guidelines will impact the rental stress test used by lenders for calculating the loan amount on your buy to let mortgage. The stress test is made up of two components, interest rate and rental cover.
The interest rate element is used to check the affordability of a mortgage in case the interest rate goes higher than the rate at which you took your buy to let mortgage. For example, even if you borrowed at 3%, the lender will check your ability to pay that mortgage at higher rate, say for example at 5%
The rental cover is a ratio between the rent achieved against the monthly mortgage payment. So if your monthly buy to let mortgage payment is £1000, your property should generate rental income of 1250, which means a cover of 125%.
Both the rate at which this cover is calculated as well the level of cover has changed. Typically the notional interest rate was around 5% and the cover was at 125%. This notional interest rate has increased to a minimum 5.50% and the cover has moved up to 145%.
For those buy to let landlords who are thinking about opting for a limited company buy to let mortgages, there are a few lenders who have different stress test for limited companies, as this ownership structure is not impacted by the changes to the mortgage interest relief.
Just to put this into perspective, if you own or intend to purchase a buy to let property generating monthly rental income of £1000, you could have borrowed up £ 192,000. Using the same rental amount, under the new guidelines, this amount will drop to £150,470.
Will it impact my existing buy to let mortgage if I apply for a like for like refinance?
This is one of the most frequently asked question and the answer is no. Existing buy to let mortgages will not be impacted if the borrower applies to refinance the same amount, even if it doesn’t meet the new stress test.
Click here to contact the Mortgaze team for initial free consultation on buy to let mortgages. We will be very happy to assist you with your buy to let mortgage application. You must take advise from a tax specialist on issues related to mortgage interest relief and transferring your buy to let properties into a limited company structure.