Borrowing against BTL for tax reasons makes no sense?

[Kots]

Dear all,

Hoping you can help me out here.

Lets assume I have a rental property worth £100k, and a main residence worth £200k. Neither property currently has a mortgage.

I need to borrow £60k for property related expenses. I can borrow on the rental property at 4% and the main residence at 2%.

I earn £6,000 per annum on the rental property and my tax off-settable expenses are £1,000 per annum so net of £5,000.

On the BTL, with a mortgage of 60k, my interest charge is £2,400 and so my net, after interest deduction is £2,600.

On the residential £60k mortgage, my interest charge is £1,200 and so my net, after interest deduction is £3,800.

So although I do not have a ‘tax shield’ in the form of interest cost of £1,200 (assuming here I can’t offset residential mortgage against BTL property for tax reasons) this is double the cost of the ‘tax shield’ on the BTL. So here are the numbers:

Borrow on BTL and make, after tax:

@20% : £2,600 - £520 = £2,080
@40% : £2,600 - £1,040 = £1,560
@45% : £2,600 - £1,170 = £1,430

Borrow and Residential and make, after tax:

@20% : £3,800 - £760 = £3,040
@40% : £3,800 - £1,520 = £2,280
@45% : £3,800 - £1,710 = £2,090


In each case, I make more, after tax, because the interest rate on my residential mortgage is double the rate on my buy to let.

Therefore I think it makes absolutely no sense to borrow money against your BTL, just for the fact it can be offset against tax, because, in general, BTL rates are much higher than residential rates. If the two were equal, or if BTL rates were below residential rates, then the argument is valid for tax reasons.

Additionally, interest is a regular, monthly outgoing, payable no matter whether the property is occupied, habitable, or even standing. Tax, on the other hand is payable only on income earned, after expenses.

Given the above, why is it common wisdom that mortgages on BTL’s should be maxed out?

Sure, there is an argument you can use this £60k and speculate on the stock market or foreign exchange or some other similar risky, high return investment and, therefore your interest cost is tax deductible. But lets face it, how many people would borrow to invest, or more to the point, speculate on an asset that is not property related and/or does not pay a regular income? For a conservative investor, this methodology makes no sense!

What are others opinions on this?

[King_Maker]

In your example above, the comparison is easy - the net interest cost is 1.6% pa. v. 3.2% pa., for a 20% taxpayer. Bit of a "no-brainer".

[theartfullodger]

Sorry, can't be a*s*d to do the sums myself - but when interest rates rise?? (they will, they will, even if you have a fix for a couple of years...).

[QuestForFreedom]

Woah! Too many numbers. What's the £60k for?

[Claymore]

I'm easily confused. Can someone explain to me..............:-(

[Kots]

Hello Claymore, I think the example shows that it may be better, in certain circumstances, to borrow money against your residential property, instead of your BTL property as I think there are no tax benefits, and in some cases it actually could be disadvantageous to borrow against your BTL.

I admit that this is a very simple example and others financial/tax positions may be more complex than this.

Taking it a bit further, it may then be better to buy a BTL property in cash, because although the interest cost offsets the tax due, the interest cost in itself is costing more than the tax it is saving you. Yes you could split this money and buy two or even three properties with it and make more money, but as theartfullodger says, once rates start to rise by more than a couple of percent, the debt on your multiple properties works against your cashflow in that the interest cost starts to rise quite aggressively.

QuestForFreedom, the £60k is just a random number.

[Claymore]

Hello Claymore, I think the example shows that it may be better, in certain circumstances, to borrow money against your residential property, instead of your BTL property as I think there are no tax benefits, and in some cases it actually could be disadvantageous to borrow against your BTL.

I admit that this is a very simple example and others financial/tax positions may be more complex than this.

Taking it a bit further, it may then be better to buy a BTL property in cash, because although the interest cost offsets the tax due, the interest cost in itself is costing more than the tax it is saving you. Yes you could split this money and buy two or even three properties with it and make more money, but as theartfullodger says, once rates start to rise by more than a couple of percent, the debt on your multiple properties works against your cashflow in that the interest cost starts to rise quite aggressively.

QuestForFreedom, the £60k is just a random number.

Yes, I think I can understand what everyone's saying. However, when interest rates rise and mortgage rates go up, so do interest rates on savings. I think you have to look closely at all the factors to see which is best scenario as and when you buy.

[doobrey]

In each case, I make more, after tax, because the interest rate on my residential mortgage is double the rate on my buy to let.

Did you not mean the opposite? Interest rate on residential is half that of BTL?

The conventional wisdom on keeping property portfolios at a high LTV is to do with leverage, I would say, not tax. As long as the yield is good enough, then generally speaking the more leverage the higher the ROI (and, of course, risk). Therefore there is an argument for borrowing as much as possible and buying as much as possible.

[doobrey]

For a conservative investor, this methodology makes no sense!

Agreed. It makes no sense to borrow against a BTL and then put the money in the bank. It can make sense, however, if you want to put it into something with a better return.

[badbobby]

To the OP

You can have your cake and eat it - if you borrow against your house and use the money for a BTL then you can offset this against tax.

It becomes tricky moving forward as you have to make a judgment call on how you deal with the mortgage going forward though.

e.g. You have £150k mortgage on your residential property and then borrow a further £50k to use as a deposit on two buy to lets.

You can then offset 25% of the residential mortgage interest against tax (being £50k/£200k)

Where it gets difficult is that in 5 years' time you could have £180k o/s and you want to take out another £20k. I would say that of that £180k, 25% is business debt, which would be £45k. Then you borrow £20k, so you now have £65k of business debt equating to 32.5% of the debt. So as you keep progressively take money out, more and more becomes business debt and therefore allowable.