What are the tax implications when changing a buy-to-let mortgage from interest only to repayment?
I have a buy to let property on a interest only mortgage, I was wondering what are the tax implications if I move it to a interest and capital motgage?
On the face of it little changes initially.
When you are receiving income from your rental property you are only able to offset the interest of the mortgage against the income, irrespective of whether it is Interest Only or Capital Repayment. After taking into account any other allowable expenses you are then taxed on the rest of the income.
Initially the biggest impact of switching to Capital Repayment is that it will be a little more complicated for you to calculate your tax bill. With an interest only mortgage you just use the total of the payments made in that tax year (as it is all interest) when calculating the tax due. With a capital repayment mortgage you will need to actually see the amount of interest charged on a statement. You'll then need to add the correct months together, unless your mortgage exactly mirrors the tax year. Some mortgage statements do not make that a simple job!
You should be very clear that you cannot claim all of a Capital Repayment mortgage repayments against the income, so it will not reduce your taxable income from the rental. In fact over time it will actually INCREASE the tax due each year. This is because as you begin to reduce the actual mortgage balance, which is what happens with each payment, the interest charged on the mortgage also reduces, thereby increasing the taxable difference between the rental & the Interest. That's why most mortgages are Interest only for Buy to Let, otherwise you end up with little or no income in the pocket on a monthly basis, and a tax bill at the end of the year that you haven't got the cash to pay!
I suppose you need to ask why you would switch to Capital Repayment, and what difference it would make to you really? The only answer is the "comfort" of knowing one day you'll own the house.
This might be useful when you reach retirement when you want this to be a proper income stream that may be within your tax allowances for example.
If that were the case it may well be better to invest separately (in a Tax free ISA for example) so that you build sufficient funds to pay off the Interest only mortgage at that time.
Most Buy to Let lenders expect your rental income to be about 25/30% more than your mortgage repayment, so that makes it harder to raise the mortgage on a Capital Repayment basis.
When you eventually sell your Buy to Let you are likely to have to pay Capital Gains Tax of 28% on the gain. Effectively this is the original purchase price, plus the cost of buying (Solicitors fees etc.), taken away from the price it sells for (less the selling costs).
When declaring to HMRC this it is simpler if you have had an Interest only mortgage, because the mortgage balance is the same throughout. Your calculation should be as simple as the amount you end up with being paid into the bank after selling the house (which are the proceeds after sales costs), and take away your original deposit and solicitors fees etc. If you have had a Capital Repayment mortgage the amount paid into your account will also include the amount paid off the mortgage by you, so it is a little harder to confirm the numbers. It will still be the same overall, but not as clear to see or prove.
I hope that helps
Financial Planning Designer
If you would like to contact Darren for help with your financial affairs then click here.
Looking for a financial adviser near you?
Do you need financial advice? An independent financial adviser can show you how to make the most of your money.
Simply find your nearest qualified and regulated adviser using the UK’s largest adviser search.