Buy-to-let landlords face tough times ahead, with mortgage rates set to rise and new tax rules ready for enforcement. Additionally, further regulation of the sector, including the obligation to check tenants’ immigration status, is bad news for investors.
Already, two million small-time landlords are blamed for the housing crisis. In cities with a lack of supply and fast paced house price growth, such as Bristol, buy-to-let investors are blamed for price rises, driving up rents and preventing young, aspiring homeowners from getting onto the property ladder.
When Chancellor George Osborne revealed changes to landlords’ taxation in the summer Budget, many applauded him.
He said: “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. The ability to deduct these costs puts investing in a rental property at an advantage.”1
But is this a fair point? Are landlords at an advantage over first time buyers, or any homebuyer for that matter?
Tax
Currently, first time buyers, like all owner-occupiers, pay their mortgage costs out of taxed income.
All homeowners do not pay Capital Gains Tax (CGT) on any increase in their home’s value.
At present, landlords pay income tax on the profits they make after they deduct the costs of letting their property, including mortgage interest, from their rental income.
This ability to deduct mortgage costs before reaching a taxable profit is the perk that Osborne is now withdrawing.
Under the changes, landlords will instead receive a tax credit worth 20% of the interest they paid for the year.
Landlords must pay CGT, charged at 28% of the gain for higher-rate taxpayers, on any gains made when the home is sold.
Mortgages
Do Buy-to-Let Landlords have an Advantage over First Time Buyers?
Investors have an immediate advantage over first time buyers regarding mortgages, as it is easier for them to obtain an interest-only loan; monthly payments on interest-only mortgages are much lower.
For example, monthly payments on a 25-year capital repayment mortgage of £200,000 at a rate of 4% are £1,067. The same mortgage on an interest-only basis costs just £667 per month.
Owner-occupiers do not have much choice when it comes to interest-only deals, with the majority coming off the market.
However, buy-to-let investors must still repay the capital loan.
Additionally, David Hollingworth, of broker London & Country, observes that they pay more interest overall, as the capital loan does not reduce: “This is the downside of interest-only borrowing.
“Lower monthly payments might help cash flow, but overall interest costs can be significantly higher.”1
However, owner-occupiers have the advantage when it comes to price, as buy-to-let mortgages are typically one to two percentage points higher than the equivalent homeowner loan rates.
Calculations
The following figures assume that the first time buyer and the landlord have the same deposit amount – £75,000 – and purchase the same property for £300,000.
The £225,000 mortgage has an average rate of 3% for the first timer and 4% for the investor.
The first time buyer has the mortgage on a 25-year term and the landlord’s loan is interest-only.
The landlord, paying tax at 40%, receives rental income of £12,600 per year, creating a yield of just over 4%.
Supposing that mortgage rates and rental income remain the same for the 25 years, the landlord makes no claims for costs other than mortgage interest, and house prices rise by 6% annually, here’s the comparison:
First time buyer
The homeowner borrows £225,000 and buys a home worth £300,000. Their monthly repayments are £1,076.77 for 25 years at a rate of 3%. The total mortgage payments equal £323,031.
After 25 years, at a yearly growth of 6%, the home is now worth £1,339,491.
Deducting the mortgage cost plus the deposit (£323,031 + £75,000) equals £398,031.
The buyer’s total gain, on selling the home, is £941,460.
Buy-to-let landlord
The investor borrows £225,000 and buys an investment property for £300,000. Their monthly interest-only payments are £750, or £9,000 per year. The landlord receives annual rental income of £12,600.
Their annual net income before tax (£12,600 – £9,000) is £3,600 and after tax at 40% is £2,160.
After 25 years, the property is worth £1,339,491.
Adding a total net income over 25 years (£2,160 x 25) of £54,000 equals £1,393,491.
Deducting total mortgage interest (£9,000 x 25) of £225,000 equals £1,168,491 and the deposit of £75,000, plus the repayment of the capital loan (£225,000) equals £868,491.
When the CGT of 28% is deducted from the capital gain (£1,039,491 x 0.28), £291,057.48 is subtracted.
The landlord’s total gain, upon selling the property, is £577,434, in comparison.
1 http://www.telegraph.co.uk/finance/personalfinance/investing/buy-to-let/11865435/Do-buy-to-let-investors-REALLY-have-a-tax-advantage-over-ordinary-homebuyers.html
