Thinking of raising the rent? Here are three alternatives

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65% of landlords are considering rent hikes following the Budget announcement earlier this month, but there are alternatives worth considering.

The Residential Landlords Association (RLA) recently conducted a survey that suggested over two thirds of landlords are considering raising rents in response to the government’s decision to restrict tax relief on buy-to-let mortgage interest.

It’s entirely reasonable to want to recoup costs, but with the relief withdrawal to take place gradually over a four year period – and with just shy of two years until it starts – there is time to think about all of the options available.

Suddenly increasing rents can in fact have a deleterious effect on a rental business. In ‘elastic’ markets, where demand is particularly sensitive to rents due to a healthy supply of rental properties, rent hikes are likely to lose you custom to competitors.

Similarly, tenant incomes – which the Summer Budget is likely to have restricted through benefit and tax credit cuts, as well as a public sector pay freeze – will put a ceiling on achievable rents, and leave landlords likely to suffer voids or arrears if they attempt to charge too much.

So what can be considered instead?

Becoming a company

More big news from the Budget was the plan to reduce corporation tax to just 18% by 2020, leading many investors and property experts to ask whether now might be the time to incorporate your property business into a limited company.

There are pros and cons to this approach. Some of the plus sides include:

  • Potential tax benefits: As a company you get to keep full mortgage interest relief, meaning that you pay tax on profit rather than income, just like any other business.
  • Control of income: In a limited company setup, rental income goes first to the company rather than the owner, who can leave as much or as little of the profits as they wish in the company.
  • Transferring assets: By changing directors or transferring shares, it is possible to transfer a property to someone else without generating a capital gains tax liability through a change of ownership (as the owner – the company – remains the same). The transfer may still be subject to inheritance tax, however, so be sure to consult a qualified tax advisor.

Some of the downsides, meanwhile, include:

  • Potential tax drawbacks: Dividends are now taxed at every tax band, rather than just the higher and additional rates – and because rental income has already been subject to corporation tax, it can effectively be taxed twice when withdrawn as dividends. There is also the potential to pay stamp duty land tax (SDLT) twice on properties that were purchased before being transferring into the company structure, as well as a number of other tax implications.
  • Funding a purchase: At present, less than 50% of the buy-to-let marketplace caters to limited companies. This means reduced product choice for corporate borrowers and, typically, slightly higher borrowing costs. You might also find yourself subject to strict criteria, including the requirement that the company be set up as a special purpose vehicle (SPV) with no other purpose than to buy, sell, rent and/or manage property – meaning often development activity is not permitted.

Strongly consider seeking professional financial advice if you are considering taking this route.

Reducing your borrowing

Reducing your borrowing won’t lower your tax burden; in fact, it may increase it. But it could reduce your costs, which might enable you to offset any loss suffered through the new tax regime.

You can reduce your borrowing in a number of ways, including:

  • Selling up: If one or more of your properties are not performing as well as the others, you could consider selling them in order to reduce the debt held against the rest of your portfolio.
  • Releasing equity: Conversely, you might find that some properties are performing far better in terms of the value they have gathered over time, and are less highly leveraged as a result. You could therefore increase your borrowing in one area in order to reduce it elsewhere, bringing your overall debt level down.
  • Making overpayments: Most buy-to-let mortgages are interest-only, meaning that you don’t repay the capital debt until the end of the mortgage term, but you can still choose to make capital repayments. Most lenders permit maximum overpayments of 10% each year, and a handful allow more on certain products.
  • Switching to a repayment or part repayment mortgage: If your monthly income and outgoings are relatively static and you would like to reduce your capital debt gradually rather than in chunks, you might consider switching to a repayment mortgage. A part-repayment mortgage is another option that won’t fully reduce the debt over the mortgage lifetime, but will reduce part of it, and at a lower monthly cost than the full repayment option.

In all of the above cases, your lender may impose early repayment charges (ERCs) if you repay your mortgage before the agreed date, so be sure to talk to your lender or broker about your options.

Refinancing

Keeping your costs down can sometimes be as simple as switching mortgages. By refinancing some or all of your portfolio to the latest rates, you could reduce your overall interest repayments and help to minimise losses.

The downsides of this option include switching fees for the new mortgage, and possibly early repayment charges if you are exiting your old deal before the end of the agreed-upon term. A professional mortgage advisor will be able to help you determine whether it will be cheaper to refinance or stay on your current deal for the time being.

 

Written by Ben Gosling at www.commercialtrust.co.uk

The above article is for information purposes only, and should not be interpreted as providing actual mortgage or tax advice.


Posted by Ben Gosling, Commercial Trust on 29 July 2015

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