Should you pay off that buy to let mortgage?

Should you pay off that buy to let mortgage?

14:25 PM, 4th July 2011, About 12 years ago 2

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Should you pay off B2L mortgage?

Buy to let landlords often wonder if paying their mortgage off early is a good investment.

The answer is it depends on the borrower.

Most of us prefer not to have debt – but as a property business, landlords need to recognise some debt is good and some is bad.

If having mortgage debt on buy to let property worries you and you have the means to repay the loan, then get rid of it. There’s no right or wrong, just personal preference.

But before you rush off to transfer that cash, think the consequences through for your property business.

Property business mortgage interest is an allowable expense that landlords can set off against rental profits.

Every pound of mortgage interest reduces rental profits by a pound, and landlord tax by 20p or 40p a year, depending on if the owner is a low or high rate income tax payer.

Paying down a buy to let mortgage will increase profits and leave the property owner with more income tax to pay.

With that in mind, if the landlord has a mortgage on his or her home, then the interest on that loan does not attract any tax relief, so it makes more sense to pay that borrowing down first rather than a loan against an investment property that is a tax reducer.

Next look at other borrowings.

Credit cards, HP and other finance is likely to have a higher interest rate than a buy to let mortgage. The facility is available for landlords to draw their investment out of a buy to let property while charging the interest on any loan they take to do so against their business.

Taking cash out of the rental business to pay down those high interest rate debts frees up cash flow while reducing tax.

Dealing with mortgage debts is about landlords managing their money to their best advantage.

If a landlord does decide to pay down that mortgage – then they should look closely at their mortgage agreement to make sure any early repayment charges are not triggered.

Don’t up the payments either – in most cases, landlords are better off sticking to an interest-only mortgage while they salt away any extra cash over the financial year.

Property118 founder Mark Alexander wrote a similar article offering buy to let mortgage advice, you can read it here.

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10:18 AM, 10th July 2011, About 12 years ago

You're right, if people are risk averse, then they should pay off the debt that doesn't attract tax relieve and more expensive debt. But you're using the wrong reason for not paying off buy-to-let mortgages. You're highlighting interest tax relief as the only benefit - you get that automatically. It is said that you don't appreciate something until you lose it.

If you had 20K of cash sitting in the bank, what would you do with it? Would you use it to pay down a debt that's costing you 5%, which would save you £1000 a year? Or would you use it as a deposit + purchase costs to buy a BTL property that would rent for 500 pcm? The former doesn't need any calculations as the end figure is £1000 saving. Suppose the latter buys a property worth £75K and you got an 80% LTV mortgage. The deposit would be £15K leaving you with £62K mortgage and the remaining £3000 to pay off the purchase costs and a little bit of refurbishment.

Assuming a 5% mortgage interest rate, this would cost you £3100 a year; but the rent would be £6000. Hence, it would cashflow £2900 a year before tax. Assuming you're a 40% taxpayer, this would leave you with £1740 a year net cashflow. For a 20% tax payer it would leave you with £2320 a year net cashflow. Both of them are a far cry from the £1000 a year saving.

However, the more debt you incur, the more risk you expose yourself to. It's about your attitude to risk i.e. your risk appetite. I don't consider my attitude towards risk nor my risk appetite, I just do the maths. I leave £20K in the bank to cover serious problems that I may encounter in my investing career and, as my portfolio increases, so will the money in the bank.

I simply use 5% of my outstanding debt and round it up to the nearest round figure: 5% of £360 = £18K but I use £20K as a round figure - erring on the side of caution. My recent acquisitions, which will complete in August, will raise my debt to £585K. So my insurance policy would climb to £30K as a round figure. As my confidence grows, maybe I'll lower the insurance amount in the bank and buy more property.

That's my view of investing. Everyone should decide what's best for them, what they're comfortable with. Remember, that investing IS about pushing yourself beyond your comfort zone, albeit slowly at first, until you gain that experience, expertise, and confidence. But, whatever you do, start/continue investing.

Mark Alexander - Founder of Property118

8:22 AM, 11th July 2011, About 12 years ago

Hi Kasim

If you don't mind I would like to challenge some of your figures.

£500 pcm on a £75,000 property is an 8% gross yield. At 80% LTV you could service debt at 10% if you had zero costs but that's not realistic. I always allow 20% to 30% of rent for costs such as letting, maintenance, management, insurance etc.

Therefore, if we allow say 25% of rent to cover costs, that leaves net rent of £375 pcm. That would give you a cashflow breakeven position at an interest rate payable of 7.5%. Still very good but it worries me when people forget to factor in costs. I see net cashflow advertised on BMV deals all the time but the figures quoted are only net of mortgage costs.

I do agree with you keeping a cash reserve for trading purposes and as a "war chest". My target is 20% of debt which is considered high by most investors but it's a figure that I'm comfortable with as I run a highly geared and relatively modest yielding portfolio.

My strategy is long term capital growth as I have 22 years left before I'm 65. In the meantime I do not plan to take an income from my portfolio.



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