April may have come as a shock to many landlords for two reasons: the first is for anyone who bought a property on a two-year mortgage, ahead of the introduction of the additional 3% stamp duty two years ago.
They are likely to have seen their rates rise this month as their introductory mortgage rate finished and they ended up on their lender’s standard variable rate.
The second reason is the phased changing of tax relief on mortgage interest. Any landlord who is a higher rate tax payer will be feeling the effects of these changes right now. For the last year only 75% of their mortgage interest will have been offset at their usual 40%, the remainder will be at basic rate, and the bills for these will be landing anytime now. As many will know, this is the start of a four-year phased introduction, so that by March 2021, 100% of tax relief on mortgage interest will only be offset at basic rate not higher rate.
For all landlords who are higher rate tax payers, this will mean that your tax liability will increase, even if your income hasn’t. For lower rate tax payers, these changes may well push you into the higher rate tax bracket.
So, what can be done?
In the first instance the answer is simple: it may be time to remortgage. There are a growing number of lenders servicing the buy-to-let market and rates are ever-more competitive as they fight for your business. The one thing to be aware of is that lenders will now need to stress test your ability to pay your mortgage using a notional rate of 5.5%. This means looking at your income and expenditure and calculating if you will still be able to pay your mortgage if rates increased to 5.5%.
There is one way around this however, and that is by taking a five-year or longer fixed rate mortgage. Because it is a fixed rate, and therefore payments will not increase over this time, the lender is permitted to calculate your ability to pay on the actual interest rate not the notional one. There are a lot of five-year fixed mortgages but not all available directly to the public, many are only available through mortgage brokers, so do get in touch if you have seen your rates rise.
The tax situation is a separate challenge. The most common solution has been for landlords to form a limited company for new purchases as the full amount off mortgage interest can then still be offset against the rent for tax purposes. This is not the right advice for everybody however so it is very important to take tax advice before doing this. For a lower rate tax payer who only has two or three properties, keeping them in your own name may still be the best thing to do. It is those in the higher tax brackets who need to think carefully about transferring their properties into a limited company – or at least buying all future properties in this way.
Transferring property into a limited company needs to be carefully thought through as it does not come without costs. Because the limited company is a separate legal entity, it means you need to ‘sell’ the properties to the company which will incur capital gains tax for the individual, and the company will need to pay the additional stamp duty.
Once the company is set up however it means that you will pay corporation tax on any profits the company makes which for some could be more advantageous. When underwriting an application for a company, the lender will look at the Directors and majority shareholders of the business, for example where they are located, income status, credit status etc. Some lenders will allow more than the traditional normal 4 applicants if you set up a company with multiple shareholders and Directors which could have tax planning advantages.
Most lenders no longer differentiate on the rates made available for limited companies versus individual applicants, but there are still a number of criteria elements to navigate. If you have taken Tax advice and decided a limited company mortgage is right for you, then do seek mortgage advice also from a mortgage company, like Connect, who specialise in this area to ensure you achieve the best finance options available.