BTL (Buy-to-Let) has long provided some very good returns for investors, but a number of clouds on the horizon have signalled some serious concerns. Changes to stamp duty, tax relief and new lending rules in the UK could significantly reduce the likelihood of being able to make money from letting property.
The national picture is not always replicated here in Harrogate and its surrounds as house prices are still increasing in a buoyant marketplace and good rental property is in short supply. Here then in brief are the key points.
The Challenges
Stamp Duty
Property buyers pay stamp duty progressively based on how much over a threshold their purchase is.
You pay no stamp duty on the first £125,000, then 2% on £125,001 to £250,000 and 5% above £250,000 to £500,000, with rates continuing to step up above this.
This is set to change for buy-to-let landlords from April 2016, when individuals buying rental property or second homes will have to pay an extra 3% on top of every stamp duty band.
Stamp duty will be 3% on homes between £40,001 and £125,000, 5% up £250,000, and 8% up to £500,000, with rates stepping up above that.
This will clearly increase purchase costs. For example, the current stamp duty bill for someone snapping up a £275,000 home is £3,750. But this will rise to £12,000 from April 2016.
Mortgage interest relief
Mortgage interest relief has been one of the best perks of buy-to-let. You can currently claim for interest on buy-to-let mortgage payments when you do your tax return, allowing you to offset the mortgage interest against rental income.
Landlords then pay income tax at their marginal rate (the highest rate of tax you pay) on the gap between the two – i.e. their profit.
Thus, a higher-rate taxpayer can claim 40% tax relief on mortgage interest.
From 2017 the maximum tax relief rate will move towards being limited to 20%. This could severely eat into landlords’ rental returns.
Essentially, you will be taxed on buy-to-let income rather than profit.
Wear and tear allowance
From this April the ‘wear and tear allowance’ will be scrapped.
At the moment, the allowance means landlords can reduce their tax bill by claiming tax relief on up to 10% of their annual rental income to pay for upkeep of their property, regardless of whether they have made any changes.
From April 2016, the allowance will be replaced with tax relief ‘for replacing furnishings’ so landlords will only be able to deduct the costs they actually incur from doing so when calculating profit and subsequently their tax bill.
Right to rent
Landlords in England must now check any prospective tenants over the age of 18 have a right to remain in the UK and report any suspicions to the Home Office. You are required to take copies of documents, such as passports, birth certificates and driving licenses, and keep those copies safe.
Failure to do so can result in fines of up to £3,000, confiscation of rent or up to five years imprisonment. Several landlords in the West Midlands were fined during a pilot last year.
The Right to Rent scheme also gives landlords the right to evict tenants if they lose the right to remain in the UK.
Regulation
Buy-to-let mortgages make up an increasing proportion of the market.
Landlord loans made up 17.1% of new lending in the last quarter of 2015, up from 14.2% at the end of 2014, according to the Council of Mortgage Lenders.
The Bank of England has expressed concern about a potential buy-to-let market overheating.
There are also concerns that more rental properties reduce the housing stock for first-time buyers and that lack of supply contributes to rising house prices.
Last year, the Treasury approved powers for the Bank to monitor the industry through its Financial Policy Committee. This could mean the introduction of curbs on lending, meaning landlords may need bigger deposits and have less control over rents they set.
Mortgage application rules are set to get tougher by the end of March 2016 as new EU rules (the Mortgage Credit Directive) are introduced.
Any landlord defined as a consumer, rather than a professional – essentially those inheriting or renting out an old property – will have to go through more stringent affordability and income tests.
This could mean it gets tougher to get a buy-to-let mortgage and application processes may take longer.
The Positives
There will always be demand for renting
Today a fifth of households rent from private landlords. This could be because of rising house prices and a lack of affordability or just because people want flexibility.
Tenant demand remained high in the last quarter of 2015.
Record-low mortgage rates
Mortgages in both the residential and buy-to-let sector have fallen to record levels, helped by the historically low Bank of England base rate of interest.
Landlords are also benefiting from increased choice of home loans, as with no signs of interest rates rising in the near future there are plenty of competitive deals to snap up.
Yields are still stable
Landlords work out their rental yield based on the purchase costs and their annual rent.
So to work out the yield they calculate their annual rent received as a percentage of the purchase price.
For example, a property delivering £10,000 worth of rent that costs £200,000 has a 5% yield.
Gross rental yields for the end of 2015 averaged 6.3%, a slight reduction from 6.4% in the third quarter. And landlords expect them to remain at the same level as 2015 over 2016, giving an average figure of 6.4%.
Can setting up a company beat the tax hikes?
Holding your property in a company means you can still get mortgage interest relief, as you only pay tax on profits, with finance costs till offset against income.
You also pay corporation tax, rather than income tax.
Brokers have seen a surge in applications for buy-to-let loans from limited companies as landlords prepare for tax hikes starting in April.
The latest Buy-to-Let Index from specialist brokers found that 38% of applications by December 2015 were from limited companies, up from 15% in October – the month before the tax change was announced in the Autumn Statement.
There are downsides to holding your buy-to-let portfolio in a company structure.
You will most likely have to pay capital gains to move any existing properties into a company and the choice of mortgages for limited companies is smaller.
While mortgage choice in the buy-to-let market has improved, only 12% of products are currently available to limited companies.
You may also face an extra tax bill when it comes to getting money out of the company, potentially in the form of dividends.
