In our ‘How do the mortgage tax relief changes affect you?’ article, we explored the changes and their possible impact in some detail. Here we illustrate the financial impact of the reduction in buy-to-let mortgage interest tax relief with a short case study.
It’s worth noting if you are a reading this article as a non resident landlord that the same changes to the tax relief allowed on mortgage interest applies.
The adjustment to the rules should not be ignored and should be considered before you fill in your own self assessment tax return or you have your next meeting with your accountant or tax advisor.
Buy to let mortgage interest tax relief example
Sarah is a UK landlord with one property rental. She pays mortgage interest payments of £500 per month on an interest only mortgage and charges her tenants monthly rent of £850.
Annual breakdown and tax bill before the changes
- Mortgage interest = £500 x 12 = £6,000
- Rental income = £850 x 12 = £10,200
- Taxable income = £10,200 – £6,000 = £4,200
- Sarah is a higher rate taxpayer, so her annual tax bill on her property income is £1,680 (40% of £4,200).
- A basic rate taxpayer with the same financial situation would pay 20% of £4,200, which is £840.
By 2020, Sarah will be hugely affected by the reduction of the mortgage interest allowance and the introduction of the 20% tax credit system.
If she keeps her rent charges the same, in 2020, Sarah’s annual breakdown and tax bill now looks like this:
- Mortgage interest = £500 x 12 = £6,000
- Rental income = £850 x 12 = £10,200
- New tax credit = 20% of £6,000 = £1,200
- Taxable income = Full rental income – tax credit
- For Sarah, as a higher rate taxpayer, this means:
40% of £10,200 = £4,080 – £1,200 = £2,880
This is a massive increase from her previous £1,680
- A basic rate taxpayer in the same situation would pay £840, which is no increase in their tax bill. 20% of £10,200 – £1,200 tax credit)
Higher rate tax payers income reduction
For Sarah, and other higher rate tax payers, the overall income from property letting will decrease rapidly over the next couple of years as the buy-to-let mortgage tax relief is incrementally phased out.
For example, looking at Sarah’s budget and just considering the switch to mortgage tax credits from mortgage tax relief at the maximum rate of tax paid.
Sarah has £850 per month coming in from rental income and £500 going out on mortgage payments.
The incremental introduction sees a 25% reduction in mortgage interest tax relief and a parallel 25% increase in the amount of mortgage interest eligible for the new mortgage tax credit. This starts in the 2017-18 tax year and will be complete by 2020-21 tax year.
Here is how this will affect our landlord, Sarah’s, rental income over that time
2017–18 tax year: 75% mortgage interest tax relief/25% eligible for tax credit
Sarah’s tax bill:
Rental income – 75% mortgage payments = £10,200 – £4,500 (75% of £6,000) = £5,700
x 40% tax = £2,280
– 20% of remaining 25% mortgage payments = £2,280 – £300 (20% of £1,500) = £1,980
2018-19 tax year: 50% mortgage interest tax relief/50% eligible for tax credit
Sarah’s tax bill:
Rental income – 50% mortgage payments = £10,200 – £3,000 (50% of £6,000) = £7,200
X40% tax = £2,880
– 20% of remaining 50% mortgage payments = £2,880 – £600 (20% of £3,000) = £2,280
2019-20 tax year: 25% mortgage interest tax relief/75% eligible for tax credit
Sarah’s tax bill:
Rental income – 25% mortgage payments = £10,200 – £1,500 (25% of £6,000) = £8,700
X40% tax = £3,480
– 20% of remaining 75% of mortgage payments = £3,480 – £900 (20% of £4,500) = £2,580
2020-21 tax year and onwards: 0% mortgage interest tax relief/100% eligible for tax credit
Sarah’s tax bill:
Rental income – 20% mortgage tax credits = £10,200 – £1,200 (20% of £6,000) = £9,000
X40% tax = £3,600
Sarah’s Rental Income will drop dramatically, when taking mortgage payments and increasing tax bills into account:
Equation: Rent charged – mortgage payments – tax bill = annual rental income
2017–18 = £10,200 – £6,000 – £1,980 = £2,220
2018-19 = £10,200 – £6,000 – £2,280 = £1,920
2019-20 = £10,200 – £6,000 – £2,580 = £1,620
2020-21 onwards = £10,200 – £6,000 – £3,600 = £600
That’s a drop of £1,620 over three tax years.
The new 20% mortgage tax credit is not enough for higher rate tax payer landlords to maintain their current level of earning. Common sense would suggest that both rent increases and a decrease in the number of investors in the property market are inevitable. Neither is great for those living in rented accommodation, but perhaps will encourage the government’s aim of freeing up affordable housing for those buying to live in their own properties. Only time will tell.
