Mortgage refinancing buy to let properties – section 24 issues

simon

Simon Misiewicz

20th August 2019

Article relevant to the tax year 2019/20

Before we go into the details please allow me to point out that Simon Misiewicz nor Optimise Accountants are financial advisors or mortgage brokers. The information provided below is for educational purposes from a tax perspective. The information contained in this article does not constitute as financial advice. We ask that you speak with a qualified mortgage broker when reviewing your mortgages on your home or on your buy to let property investments.

You may be interested in our main article “buy to let tax for UK landlords”. This article discusses all the different types of tax that you need to be aware of as a UK landlord. Opens in a separate tab.

1. Can you remortgage on a buy to let?

It is entirely possible that a property may be refinanced. An extra amount of equity will have been built up if the property increased in value. A property may have increased in value for a number of reasons:

– Property values in the area have increased over time

– The property owner added value to the property (more bedrooms, extensions, additional garages etc)

– The property may have originally been purchased below market value

Data from UK Finance shows that landlords remortgaged 14,700 properties in July.

A buy to let landlord may be able to pull more money out of their existing mortgage provided that there is equity in the property and the mortgage holder has a good credit rating. You normally have to wait at least six months from the date that you obtained the original mortgage to the date that you seek to refinance.

Please note that you will typically pay administration and arrangement fees on any remortgage. You are advised to speak with your mortgage broker to ensure that you understand all the associated costs with a remortgage. It is likely that you will pay more interest rates on a refinance than the original mortgage. This is because the risk profile of the debt is increased. Ultimately there is less debt for the banks to pull on if things go wrong.

You can visit USwitch to see what mortgage interest rates and charges may apply to you.

The stress test criteria when refinancing your buy to let mortgages

The last thing to consider is the % of mortgage interest repayment rate. Some lenders wish to see an interest cover (stress testing) of 145%. This means that your net rent needs to be 1.45 times more than the mortgage interest charges. Lenders may not lend to you if the net rent does not meet or exceed their % criteria.

£10,000 net rent

£6,000 mortgage interest costs

The above shows that there is 1.67 times cover to meet the stress test condition of 145%. A buy to let landlord wanted to increase the mortgage and the interest charges increase as shown below:

 

£10,000 net rent

£7,500 interest rate

The stress test criteria is no longer met. This is because the cover is reduced from 1.67 to 1.33 (£10,000 divided by £7,500). It is unlikely that the lender would approve the remortgage application.

2.  Do I need a deposit for a remortgage?

You will need to find a deposit on any property that you pay. The amount of deposit that you require will be from 10% to 50% (or even more) based on the below

– Your credit report and credit rating, which you can investigate using Experian or Equifax

– The condition of the property. The greater the disrepair the greater reassurances bank will require

– The risk profile of the investment. The greater risk to the banks will mean more deposit

– How you are going to buy the property. If the property is in your name or in a company with other Joint Venture partners. The amount of deposit needed may be less if the buy to let property is purchased in your own name.

– The age of the mortgage holder. The greater the age the more equity the banks will want to see.

 

Refinancing a buy to let mortgage to release cash for a deposit on a property investment 

Let us look at an example. John has identified a property in Birmingham. It is a four-bedroom house and is near the university. The property will be rented out to students. There is a high demand so renting the property that is refurbished to a high standard should not be a problem.

£200,000 house price

£50,000 deposit being 25% of the property value

The £50,000 can come out of John’s savings account. John could refinance an existing buy to let property that is just down the road in Birmingham, which is also let out to students. He purchased the property 8 years ago when the house price was £140,000. John knows that the property is in even better condition than the one he is looking to buy. He speaks with his mortgage broker and they agree to re-finance the existing property

£140,000 original house purchase

£200,000 latest valuation on the property

£60,000 increased the value of the property.

The £60,000 allows him to take out 75% as a re-mortgage. John decides to proceed with this re-mortgage. John is now able to use the £45,000 for the deposit on the new house.

£50,000 deposit required

£45,000 released as a remortgage in the existing buy to let property

£5,000 more required for John to complete the purchase

John now only needs to pull out £5,000 from his savings account to buy the new property because he refinanced the existing Birmingham buy to let property.

The mortgage interest cost associated with the refinancing is allowed to be offset against his property income as it is used for investment/business purposes.

 

3. Can I borrow more on my mortgage to pay off debt?

There are times when people use credit cards that have obscene interest rates from 10% onwards up to 135% (or even more). It makes more sense to remortgage a buy to let property where the rates vary from 1% to 8%, which is much less than the debt that you have.

Sarah has recently purchased a new home. He decided to treat herself and her two daughters to a nice home. The property is in the countryside with plenty of typical green scenery. She has an interior designer to help her bring more light into the property and increase the size of the windows so that she can see her horses roaming near the paddocks. She spent £50,000 on the redesign. This was £20,000 more than she budgeted for. She put the money on her credit card. Sarah was worried because the credit card interest rate was 15.8%.

Sarah can refinance her two-bedroomed buy to let flat that is situated in North London. She originally purchased the property in 2009 when the property prices were very low. At that time she paid £350,000. The property has now increased to £500,000. She speaks with her mortgage broker to work out how much money she should release.

How much money may be released to pay off debt?

£500,000 new property value

£350,000 original purchase price

£150,000 increase value

The amount that she could take out is 75% of the £150,000 increased value. This would give her the choice of taking out £112,500. Albeit it does sound tempting she decides to take out just £50,000 extra mortgage. This means she will pay an extra £1,500 interest per year (£50,000 X 3% buy to let mortgage rate).

Albeit the £50,000 is not used for business or investment purposes the interest may still be offset against her rental income. This is because HMRC allows people to offset the cost of their finance provided that the total new mortgage does not exceed the original purchase price. In this case, it does not.

Sarah has now decreased the interest rate and passed on the cost onto her property business.

The downsides when refinancing a buy to let mortgage to pay off debt

As Robert Kiyosaki says that there is good debt and bad debt. Good debt is where you are increasing debt to generate more investment income. Bad debt applies where you are increasing debt for lifestyle purposes and no additional income is generated. In the case of Sarah, I think it is clear that she has created bad debt. This is despite the fact that she has decreased the interest rate charges. She will now have less cash flow from her investments for her lifestyle choices.

Sarah will also need to be upfront with the mortgage company with the reasons why she wants to take out the extra finance. The fact that she is paying off debt needs to considered by the lender and the mortgage broker. It could raise questions as to how Sarah manages her money.

Download your buy to let tax guide here, written by our property accountants

4. How do I make a property portfolio with no money?

As shown in the section “3.  Do I need a deposit for a remortgage?” it is entirely possible that you could continue to refinance existing properties and buy additional investments. There are other ways in which you can control buy to let properties without any money at all

– Purchase lease options: This is where you write up a legal document to take control of the property and in the future, you have an option to buy the property. The seller may agree to this as they no longer want the hassle of being a landlord.

– Rent to rent: This is a common term throughout the education sector of property investors. This is where you rent a single let property from a landlord and convert it into a House of Multiple Occupation (HMO). This helps you to pay 60% to 85% of the market value rent to the landlord and you keep the rest.

– Use Joint Venture money: Working with other people may give you greater access to money for you to make property purchases.

– Sell one of the properties that are not performing very well. This enables you to release some cash to buy a better performing asset.

– It is also possible to have a secondary lender provide a loan to you. This means you could have two mortgage lenders on one property.

There are many ways in which you can purchase buy to let property investments with no money at all. Sometimes it just takes a little creativity for you to achieve it. Warren Buffet as quotes several times, saying it is better to control the asset than to own it. There is a lot to be said about this approach.

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5. Is it best to pay off buy to let mortgages?

Most clients of Optimise Accountants that are property investors typically opt for an interest-only mortgage. This means that none of the debt is being paid off. The debt will remain the same at the end of the mortgage term. All that is paid by the buy to let property investor is the mortgage interest costs.

What happens if the property investor dies?

Typically banks want their money back after 12 months unless the debt is assigned to someone else. If this cannot happen then the estate needs to have money in savings accounts or sell of the property portfolio to pay off the buy to let mortgages. This could be a disaster if the estate finds themselves in a recession and unable to sell the properties at the market value. They may need to be sold, below market value, in order to release the cash to pay off the mortgage

The person that spent many years to build up equity in their property portfolio may be saddened to see that the values are wiped away. It is therefore important to consider how the debt is to be paid off in the event of the mortgage holder’s death. It may be a better option from a wealth planning aspect to put the properties in a repayment mortgage. They need to be aware that this will decrease the amount of cash flow that they receive from their property portfolio.

Other key benefits of paying off your buy to let mortgages

Another good reason for paying off the buy to let mortgage is to increase the cash flow of the asset. The less mortgage, the less interest. This means you have more cash flow to play with.

There may also be times where the property is providing you with a negative cash flow each month because of the mortgage interest/ capital payments. Decreasing the debt means that the interest and capital repayments will also be lower. This should help improve cash flow, especially if you are making a loss each month. An investment, after all, needs to bring in money into your bank account.

6. What are the implications of refinancing a buy to let property because of Section 24 mortgage interest relief cap?

We wrote an article all about Section 24, mortgage interest relief cap.

In the article and video, we discussed how landlords from 2020/21 will not be able to offset the mortgage interest costs against their property income. From 6th April 2020, buy to let property investors will only receive a tax reducer of 20% of the mortgage interest costs. This means that high rate taxpayers will lose 20% tax relief on mortgage interest costs. Additional rate taxpayers will lose 25% tax relief on the mortgage interest costs.

You may not be able to offset the full amount of mortgage interest costs if you refinance a property and a high rate / additional rate taxpayer.

From the above example, we could see that John already has one property in Birmingham and looking to buy another. The first property had the following characteristics

£140,000 property value

£105,000 mortgage

The mortgage had an interest rate of 2%. This means that the mortgage interest costs per year were £2,100. In 2016/17 John’s tax return looked like this from the one property in Birmingham.

£15,000 income

£2,100 mortgage interest costs

£5,000 other costs

£7,900 profit

As a high rate taxpayer, he knew that 40% of the profits would be paid to HMRC. The amount of tax that John had to pay on his Birmingham property was £3,160. This leaves John with £4,740

6th April 2020 mortgage interest relief cap impact in John’s property

If we roll forward a few years we will see that the mortgage interest costs will not be allowed to be offset against his property income.

£15,000 income

£5,000 other costs

£10,000 profit

£4,000 tax

(£420) tax reducer at 20% of the mortgage interest costs of £2,100

£3,580 net tax to pay

We can see that John now has £420 more tax to pay.

 

If John were to refinance the original property and increase the buy to let mortgage by £50,000 the following would apply

£1,500 additional interest because of the remortgage.

£300 tax relief

£300 lost tax relief because of the tax changes

In this instance, John is paying more tax as a result of the original mortgage. He is also paying more interest on the remortgage without the benefit of the full tax reliefs.

 

If you want to know more then please read our “buy to let tax tips for UK landlords” article

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