From Dr Mark Blakey
Recent letters on buy-to-let propositions have debated some interesting fundamentals. Sohan Jheeta (Mortgage Strategy, July 1 2002) talks about interest on capital raised for commercial purposes being treated as an allowable expense that reduces the taxable income on rent received.
What wasn't mentioned though, and I would be interested to hear from others more knowledgeable on UK tax law than myself, is what happens to holders of flexible mortgages originally set up for financing the borrower's own home, when they make additional drawdowns to fund an investment?
If part of the debt is for personal purposes and part is for business purposes, and many lenders are happy to allow redraws and additional drawdowns without discriminating on the purpose, then the borrower may be in for a nasty surprise when they submit their next tax return if they fail to adequately quarantine personal from business debt.
While it may be possible to split the interest on personal and business debt, it becomes much harder to do so credibly when a single facility such as a current account mortgage is used for both purposes.
Given that the fundamental nature of these loans encourages borrowers to use them as an 'all-in-one' bank account, with their salary income and all expenses directly hitting the account, every ATM withdrawal is technically increasing the debt and hence their non-deductible interest bill.
Such borrowers may be better off looking for an interest offset facility so that they could clearly separate their personal transactions from their business interest charges.
I was also interested to see suggestions that borrowers are better off with a capital and interest repayment loan rather than an interest-only loan. Sohan Jheeta argued this on the basis that, with an interest-only loan, the original debt remains to repay at the end of the term. But what if the borrower intends to build up a portfolio of investment products?
The factor that limits most people's ability to expand a property investment portfolio is their ability to service the increased debt, especially when capital is being repaid. This often translates into having to wait until a given minimum repayment on the total debt would be affordable, taking a conservative proportion of the total rental expected into account.
My company is in the process of generalising our new 'Buy-to-let Wizard' (Mortgage Strategy July 9 2002) to model buy-to-let portfolios. It's clear from our simulations that use of an interest-only facility significantly accelerates the rate of portfolio expansion, final net worth and final rental earnings, even though capital may still remain payable at the end of a given investment period.
By limiting the maximum debt and the date of the final purchase, the rental income alone can quickly repay the capital. Furthermore, when the portfolio grows to a critical mass, the portfolio can continue to expand on a self-funded basis. This means that the borrower can cease contributing any part of his personal income to the portfolio and, in the later years, can supplement his earnings by drawing down a proportion of the portfolio rent as personal income. We've found that investors on quite ordinary levels of income could expect to own between six and 20 properties over a 25-year term, achieving a very nice nest egg for retirement.
What's also really interesting is that the investment scenarios are not nearly as sensitive to lower rental returns and increasing mortgage interest rates as people might expect. Naturally, under adverse assumptions the final number of properties and the return will be reduced, but the results can remain outstandingly attractive.
Any comments from brokers, advisers (both mortgage and tax) and lenders (product designers in particular) would, I'm sure, be of interest to all.
Dr Mark Blakey
From Dr Mark Blakey