The different types of mortgages explained

The different types of mortgages explained

Repayment mortgages

A repayment mortgage is where you pay back the capital and the interest of your mortgage together. At the end of the mortgage term, you will have paid off the entire mortgage.

Interest only

With an interest-only mortgage, you initially only pay back the interest on a monthly basis and repay the capital (mortgage) at the end of the mortgage term, meaning your monthly repayments will be lower. People with interest only mortgages tend to invest the money they are saving with the view of paying off their mortgage at the end of the term.

NB. You’ll need to demonstrate to the lender that you’ll have some way of paying off the debt in the future. Interest-only mortgages are commonly chosen when you’re buying to let.

Fixed rate mortgages

The interest rate you pay will stay the same throughout the length of the deal no matter what happens to England’s interest rates.

Lenders normally advertise fixed rate mortgages as ‘two-year fix’ or ‘five-year fix’, along with the interest rate charged for that period.

Variable rate mortgages

With variable rate mortgages, the interest rate can change at any time and is not fixed. Interest payments are adjusted at a level above a specific benchmark or reference rate.

Variable rate mortgages can come in various forms:

Standard variable rate (SVR)

This is the normal interest rate a lender charges and it will last as long as the mortgage term or until another mortgage deal is taken out.

Changes in the interest rate might occur after a rise or fall in the base rate set by the Bank of England.

Lenders tend to automatically put you on their standard variable rate as soon as the term on a fixed term mortgage is over; this is often not the best rate available.

Discount mortgages

This is a discount of the lender’s SVR and usually only applies for a defined length of time, normally two or three years. Once you come to the end of that period, you start paying the more costly SVR, unless you remortgage onto a better deal.

Tracker mortgages

Tracker mortgages follow the Bank of England’s Base Rate and rise or fall along with it. If England’s base rate rises by 1% so will your mortgage.

There are ‘lifetime’ trackers for the life of the mortgage, and term trackers which may be for two or three years.

Offset mortgages

Offset mortgages link your savings and current account to your mortgage so you can reduce the amount of interest you pay on your outstanding mortgage balance.

You still repay your mortgage every month as usual, but Instead of earning interest on your savings, you will reduce the amount of interest charged on your mortgage.


*This article is for general awareness only and does not constitute legal or professional advice. The law may have changed since this page was first published.

Five house hunting tips to consider now that will help you long term.

Five house hunting tips to consider now that will help you long term.

We’ve listed some tips to consider that may influence the price and pace at which you may be able to rent or sell your property in the future.


Look near a station

Don’t look more than a mile away from a station and search by station name rather than area. Whether you’re renting out the property or planning to live there yourself; nobody wants to be too far away from transport links.

Understand differences between local areas

Sometimes going across the road into another area can have a significant impact on house prices. As an example, compare the price difference between similar properties in an area like Harold Wood and Harold Hill (London Borough of Havering). Whilst they are literally across the road from each other, the price difference is stark. Choosing the right location can have a BIG impact on future growth/rental income.

Old build v new build

We’ve all heard people say, “new build properties aren’t built as well as old build properties”.  Whether or not that is the truth is hard to say. However, many people believe this to be the case and can often be a deal breaker for prospective buyers (not so much tenants). On the flip side, if you’re buying to rent, a brand new apartment tends to be more desirable for prospective tenants.

Road appeal

Whether you like it or not, kerb/street appeal affects the desirability of a property. Ideally you want to buy the worst property on the best street rather than the best property on the worst street. Always check the street view before going to view a property and have a look at the surroundings. Streets with buildings such as pubs, old housing estates or cemeteries can often put off buyers/renters. Living on a busy/main road can also be off putting to many because of noise pollution and general busyness. 

Lease length

A leasehold property with a short lease reduces the value of the property and the lease can also be costly to extend. A “short lease” is generally regarded as a lease with fewer than 80 years remaining.

Including all fees, the cost to extend a lease can run into £10,000s for properties with only 60 to 70 years remaining on the lease. Properties with less than 60 years remaining, can be even more expensive to extend.


*This article is for general awareness only and does not constitute legal or professional advice. The law may have changed since this page was first published.

10 Questions all Buy To Let Investors should ask themselves before investing in a property.

10 Questions all Buy To Let Investors should ask themselves before investing in a property.

1. What gross yield or return could be received from the property? (You can then compare these calculations against different properties/investments)

2. Will you let it out to an individual, family or multiple people?

3. What are the prospects of future capital growth for the property and location?

4. What is the potential rental income you can get from the property?

5. What is the demand in the area for the type of property you are investing in?

6. Who is your ideal tenant?

7. How easy will you be able to sell the property if and when the time comes?

8. What are your short and long term plans for the property?

9. What impact will buying the property have on your ability to purchase more properties in the future?

10. What will be tax implications of you buying the property?


*This article is for general awareness only and does not constitute legal or professional advice. The law may have changed since this page was first published.

Budget 2021: Key property changes explained

Budget 2021: Key property changes explained

1. Mortgage guarantee (95% mortgages)

What is it

The mortgage guarantee scheme is designed to increase the appetite of mortgage lenders for high loan-to-value lending to creditworthy customers. It will provide lenders with the option to purchase a government guarantee that compensates them for a portion of their losses in the event of repossession.

How does the scheme work

The government will provide lenders with the option to purchase a guarantee on the top- slice of the mortgage. In other words, the government will compensate lenders for a portion of the net losses suffered in the event of repossession.

The guarantee will apply down to 80% of the purchase value of the property and will be valid for 7 years.

Lenders will also take a 5% share of net losses above this 80% threshold. This will help to ensure that lenders are not incentivised to originate poor quality loans.

How long is the scheme around for?

The scheme is intended as a temporary measure. It will be open for new mortgage applications from April 2021 to December 2022,

What is the eligibility criteria?

To qualify for the 95% Mortgage guarantee scheme, the mortgage must:

  • Be a residential mortgage (not 2nd home or buy-to-let)
  • Be taken out by an individual(s) rather than a company
  • Be on a property worth £600,000 or less
  • Have a LTV of between 91% and 95%
  • Be originated between the dates specified by the scheme
  • Be a repayment mortgage and not interest-only
  • Meet standard requirements in terms of the assessment of the borrower’s ability to pay the mortgage

NB. The Chancellor says that major lenders such as Barclays, HSBC, Lloyds Bank, NatWest and Santander will be offering deals from April, with others including Virgin Money to follow shortly after.

Does the scheme benefit investors?

If you’re an investor looking to sell, it may benefit you as prices are likely going to be pushed up as a result of the 95% mortgages. However, the scheme is not open to those purchasing a 2nd home or buy to let property.

Does the scheme benefit first time buyers?

Yes, you will be able to put down a 5% deposit rather than 10% which most lenders currently require. This should hopefully allow buyers to get on the ladder at an earlier stage. It will also be a requirement that participating lenders must offer a 5 year fixed rate product as part of their range of mortgages offered under the guarantee. This gives buyers security of predictable repayments for a longer period.

What are the downsides?

Affordability will still be an issue for most first time buyers. Whilst putting down a smaller deposit is helpful, those that don’t earn a big enough salary will be in the same position. The only hope is that lenders may increase their income multipliers as a result of the guarantee from the government. Watch this space!


2. Stamp Duty

What has changed

Stamp duty land tax has been suspended on the first £500,000 of all sales in England and Northern Ireland since July 2020 due to Covid

(NB. Investors have still needed to pay a 3% surcharge on purchases up to £500,000)

The stamp duty break will now continue until the end of June.

After that the nil rate band will be set at £250,000 – double its standard level – until the end of September.

How does this impact investors and first time buyers

First time buyers pay no stamp duty on properties worth up to £300,000, therefore, the doubling of the nil rate to £250,000 from June to September has no impact.

From the end of June to September, investors will pay 3% stamp duty on purchases up to £250,000 and then 8% for purchases between £250,001 and £925,000.


3. Corporation tax

What has changed

  • Corporation tax paid on company profits will increase to 25% in April 2023
  • Businesses with £50,000 profits or less will be taxed at the current rate of 19%
  • Only businesses with profits of £250,000 or more will be taxed at 25% rate
  • The rate will be tapered up for businesses as they get closer to the £250,000 profit level.

How does this impact property?

If you’re buying or have bought a property in a limited company, you will potentially pay more tax on your rental profits if your profit is over £50,000.

NB. Currently, corporation tax is 19%.



*This article is for general awareness only and does not constitute legal or professional advice. The law may have changed since this page was first published.

Buying a property in a limited company

Buying a property in a limited company

Following changes to mortgage interest relief and potential tax savings, many property investors are choosing to buy property in a limited company rather than in a personal name. We have listed some of the pros and cons of buying in a limited company and how it works.

What is an SPV

A company specifically formed for buy to let or investment purposes is known as a Special Purpose Vehicle (SPV). An SPV does not conduct any trading activity as it is used for rent to come in and expenses to go out. If you have a primary activity other than owning a property e.g. you buy renovate and sell properties, it will be seen as a trading limited company.

Buy to let lenders tend to require limited companies to be an SPV as it means they won’t have to consider and underwrite the risks associated with the trading activities of a business.


Pros of buying property in a limited company

You can take a salary

As the director and shareholder of a limited company, you may choose to take a small salary and draw most of your income from the business in the form of dividends. This will allow you to pay less national insurance as limited company dividends are not subject to national insurance contributions. The first £2,000 you receive in dividends from investments is tax-free (known as your dividend allowance).

Improved tax efficiencies

Using a limited company to buy a property can offer tax benefits especially if you’re a higher rate tax payer. When a property is owned in your name, the rental profit is added to your other income and taxed as income tax. However, rental profits on properties in a limited company are taxed via corporation tax. The current corporation tax rate is 19% whilst individual income tax rates can be as high as 45%.

Future planning

It is easier to transfer property owned in a limited company to another owner compared to transferring a personally owned property to another owner. As the property does not actually change owners, you could be exempt from stamp duty, inheritance tax and capital gains tax. This is useful for investors considering transferring to family in the future.

Mortgage relief

A new buy to let system was phased in at the start of the 2017-18 tax year. From April 2020, tax relief for finance costs (including mortgage interest payments) has been restricted to the basic rate of income tax, currently 20%. The tax on landlords income is then charged in accordance with your income tax banding (20% for basic rate taxpayers, 40% for a higher rate, and 45% for additional rate). In layman’s terms, this means that all rental income is taxed at a landlord’s highest marginal income tax rate. The only concession is the 20% tax credit on mortgage finance costs.

For companies holding property, however, mortgage interest payments can still be claimed as an expense. You can read more about the mortgage relief changes here.

Less stringent stress check

Lenders assess a potential borrowers suitability by performing a ‘stress test’. The stress test determines if a borrower can afford their mortgage. The test also assesses if the borrower can afford their repayments if interest rates were to rise.

In 2017, the Bank of England’s Prudential Regulation Authority (PRA), insisted that when giving mortgages, the rent must cover at least 145% (interest cover ratio) of the mortgage payment at an interest rate of 5.5%. However, for limited company mortgages, the interest cover ratio tends to be lower at 125%.

Example

  • If a borrower takes out a mortgage of £200,000 then the monthly interest payment based on a rate of 5.5% will be £916 per month.  
  • If taking out a personal mortgage, lenders will likely want the rent to be 145% of £916 = £1383 per month. 
  • Whereas a limited company mortgage will tend to need the rent to cover 125% of £916 = £1145 per month.
  • NB. Some lenders allow for ‘top slicing’. This is when a lender allows a borrower’s personal disposable income to make up the difference between the actual rental income and the stress tested rental income amount required by the lender.

Cons of buying in a limited company

You still have to pay stamp duty 

If the property is not purchased by an individual (e.g. the buyer is a company rather than a person), the additional stamp duty charge will apply regardless of how many properties the company owns.

No capital gains tax allowance 

A property sold in a limited company will not benefit from the capital gains tax allowance. (£12,300). Companies are liable to pay tax on all gains whereas a property in an individual’s name will only pay tax on the gain above their tax free allowance. 

Dividend taxation 

If you take profits from the company for personal use, you will be taxed on the dividends (amount) taken out. You will however have a personal tax free dividend allowance (£2000) that you can make use of. This is something to consider if your property investments are a source of income for you. If you intend to leave your rental profits in the company to pay down your mortgage, pay your corporation tax or use it to buy more property – there will be no issue.

Mortgage rates and choice 

Limited company mortgages tend to have higher interest rates and fees compared to mortgages held in an individuals name. Speak to our mortgage advisers if you would like to explore mortgages available to you.

Extra costs

Investing via a limited company can incur additional running costs. E.g. legal fees for the purchase and remortgage processes are often higher as there is extra work involved compared to investing in a personal name. Furthermore, it is wise to invest in a property tax accountant to produce annual company accounts and provide tax advice.


Buying in a limited company – The process

Setting up the limited company

The newly formed company does not have to have any history as the purpose is to legally hold the property.

The limited company must be incorporated specifying the appropriate SIC (Standard industrial classification of economic activities) code:

  • 68100 Buying and selling of own real estate.
  • 68209 Other letting and operating of own or leased real estate.
  • 68320 Management of real estate on a fee or contract basis.

Becoming a director 

Once you have formed your company, you will become a director and be responsible for meeting the legal requirements that come with owning a business. When borrowing money through a limited company, lenders will typically take a “personal guarantee” from each company director. This means, should the company not be able to pay its debts, the directors will personally pay them. For example, should your company fall behind on mortgage repayments, the bank will ask the directors to make repayments personally.

Getting your mortgage

The process for getting a buy to let mortgage via a company is similar to getting a buy to let mortgage in your own name.

  • Generally you need a 25% deposit for a buy to let mortgage
  • In order to check affordability for a mortgage, you have to have a property in mind as affordability checks by mortgage advisors are based on rental income
  • Most lenders are likely to require a personal guarantee from directors. Meaning, if the lender  was to repossess the property, and there is still money outstanding, the director offering the personal guarantee will be liable for the remaining balance
  • Lenders may not have a minimum income requirement of £25,000 but will want to see bank statements to validate your income.
  • Company directors will be subjected to a credit check as the company itself, as a new entity, will have no creditworthiness
  • You must have a business bank account open before you get your mortgage

Moving properties to a limited company

Moving a property held in a personal name to a limited company will involve a re-sale and purchase with associated conveyancing costs, capital gains tax and stamp duty (You may also have to pay an early repayment charge). You can speak to our property tax advisor if you would like to explore further.


Summary

Owning a property through a company or personally has many advantages and disadvantages. Property is a long term investment therefore, you need to consider what your long term property goals are. Each individual case is different and the decision you make will be very much based on your personal circumstance. It is wise to discuss your current situation and options with a competent property tax adviser so you make a decision best suited to your circumstances.


*This article is for general awareness only and does not constitute legal or professional advice. The law may have changed since this page was first published.

HMRC – How are your renovation profits taxed?

HMRC – How are your renovation profits taxed?

When buying a property to renovate and earn a profit you need to consider whether HMRC will treat/tax you as a property developer or a property investor. When it comes to tax, it is important to know whether the ‘profit’ element is a capital gain or a trading profit. This will determine how it is taxed and at what rate.


Trading or investment

The tax consequences will depend on whether the property is an investment or whether there is a trade. The question is whether you are a property developer or a property investor.

Much of it comes down to your intention when you bought the property. If the aim was to buy the property, do it up and then let it out, the property will count as an investment property. However, if the intention is to buy, renovate and sell at a profit, HMRC may regard you as trading. However, an intention to sell at a profit at some point in the future does not automatically mean you are trading. Also plans change, and a property purchased as a long-term investment might be sold after a relatively short period of time as a result of a change in personal circumstances.


Badges of trade

The concept of the ‘badges of trade’ has been developed from case law and provides a series of tests that which can be used to determine whether an activity is a trade or an investment. 

The ‘badges of trade’ tests, whilst not conclusive, are used by HMRC to help determine whether an activity is a proper economic / business activity or merely a money-making side line to a hobby. Careful consideration needs to be given when deciding if a hobby has become a taxable activity. The nine badges of trade are as follows

  • Profit-seeking motive
  • The number of transactions
  • The nature of the asset
  • Existence of similar trading transactions or interests
  • Changes to the asset
  • The way the sale was carried out
  • The source of finance
  • Interval of time between purchase and sale
  • Method of acquisition

Where there is a trade, the property will only be held for as long as it takes to do up and sell. A property developer is likely to develop more than one property, either simultaneously or in succession. Where there is a trade, the property will be sold to realise a profit; for an investment property, the sale may be triggered by other factors.


Case study 1

Chioma inherits some money and invests in a property, which he plans to do up and rent out. He completes the renovations and rents the property for six years before selling it to enable him to buy a larger family home.

The property was purchased as an investment and would be regarded as an investment property. The gain on sale would be liable to capital gains tax.

Case study 2

Joshua sees a run-down property on the market and spots the opportunity to make a profit. He buys the property, spends six months renovating it, selling once complete, making a profit of £40,000. He invests the proceeds in another property to renovate and sell.

Mark would be treated as trading. His aim is to sell the properties at a profit. Consequently, he would be liable to income tax rather than capital gains tax on the profit.


*This article is for general awareness only and does not constitute legal or professional advice. The law may have changed since this page was first published.