Buy-to-let has been seen as a winning investment strategy for decades; but an ever-worsening housing crisis has led to government measures to restrict the ownership of second properties.
1.4 million landlords in for a nasty surprise
In the summer of 2015, the Chancellor announced the 3-year phasing out of the offsetting of mortgage interest against tax, from April 2017 until 2020/21.
The move attracted considerable comment in the media, particularly when it was followed in November of the same year by the news that a Stamp Duty surcharge would be levied on all second homes.
But astonishingly, a recent survey by Tenant Referencing UK indicated that 70% of the nation’s buy-to-let landlords were still unaware of April’s changes to the way they’re taxed.
Changes to tax, Stamp Duty and lending criteria
The new tax regulations affect buy-to-let landlords in three main areas:
- Abolition of tax relief – until now, landlords have been able to claim tax relief on mortgage payments at their marginal rate of tax.Between April 2017-2020, all landlords will be taxed on the full amount less tax relief charged at 20%; thereafter, tax relief will be scrapped completely. For a higher rate taxpayer, this could well make leveraged buy-to-let uneconomic
- Abolition of wear and tear allowances – until last year, landlords were able to deduct 10% of the annual rental income for wear and tear. Today, only actual expenditure incurred in the current tax year can be charged
- Changes to Capital Gains Tax – reduced last year to 10%, except for those selling property (in which case basic rate taxpayers are charged 18% and higher rate taxpayers 28%)
Mortgage lending criteria have also changed. Traditionally, buy-to-let mortgage applicants have had to demonstrate that the cost of the mortgage was covered “x 1.25” by the rental income. The Prudential Regulation Authority (PRA) now requires the borrower to show that if interest rates were to rise to 5.5%, the mortgage will still be covered “x 1.25” by rental income.
It has also introduced an Affordability Test, which requires borrowers to prove they can still service the mortgage after taking into account:
- National Insurance payments
- All renting-associated costs
- Income net of tax
- Credit commitments and committed expenditure
- Living costs
All these changes would seem to work against leveraged buy-to-let, especially for a higher rate taxpayer – even assuming they satisfy the PRA’s affordability conditions.
The changes in practice
Take, for example, a higher rate taxpayer with a £100,000 interest-only mortgage owning a flat producing £750 per month rental income and costing £1,000 per year in service charges and ground rent.
In March 2016, they’d have made £1,560 NET profit. In April 2020, the same landlord and the same property will make just £360 NET because of the changes in legislation.
And the upshot?
All these changes would seem to indicate that the days of mortgage-leveraged buy-to-let property are probably over – especially for higher rate taxpayers.
By April 2020, even assuming an investor can satisfy the PRA’s affordability conditions, a buy-to-let mortgage will make little economic sense – as the example above demonstrates.
And given the research, those landlords who are currently in denial or ignorant of the new legislation are in for a very rude awakening indeed. They would be well-advised to have an urgent review of their investments, possibly starting with high-yielding property alternatives.
How an Emerging Property investment counters this problem
Because of the housing shortage, the government is actively funnelling students into purpose built accommodation – which is classified as commercial property and is therefore free of any Stamp Duty (up to £150,000).
Continually increasing student numbers guarantee long-term demand for our properties, which is why we can offer our investors pre-contracted 8-10% NET income, fixed for 10 years – with no further charges whatsoever.