How to calculate the Mortgage tax relief changes made by the Summer Budget 2015

How to calculate the Mortgage tax relief changes made by the Summer Budget 2015

How George Osborne's tax raid will destroy your portfolio's cashflow by 2020

I've been going through the news meticulously over the weekend just to get my head around what's been happening with this issue. If you're not aware of this, the brief recap would be that George Osborne brought in a change to the mortgage tax relief policies in the latest Summer Budget and these changes are going to be devastating (according to the journalists).

I've followed this news since it was public and it's been interesting to hear the arguments for and against the new policies and also commentators from the property world talking about how this will affect landlords. There's been so much debate that I became unsure how this would affect me, although I had a gut feeling it was going to be bad, and clearly already someone has created a petition to reverse these new rules.

Interestingly, this is part of the current governments plans to cut the deficit in the UK and it is estimated that by 2020 when all the changes have been phased in, it will generate £665m for the Exchequer. In fact details of this policy were hard to track down, after a couple of hours of searching around the website I found the details which allowed me to do my own calculations. (link to policy here)

The reason I had to do my own figures were twofold, firstly that most of the illustrations on various websites were not detailed enough on how the numbers and policy impacts actual property deals and financials, and secondly I needed the illustrations to work on my own portfolio to see how it is impacted by the changes.

I needed to know what the bottom line would be in 2020, but I also needed to find out how the phasing worked over the next 5 years.

To highlight the key points of the policy changes here:

  • Wear & Tear allowance of 10% will be eliminated from 2016 in preference of actual incurred costs.
  • 100% to 0% relief phased in from 2017-2020 in the following manner
    • 75% for 2017 to 2018
    • 50% for 2018 to 2019
    • 25% for 2019 to 2020
    • 0% for 2020 to 2021 and beyond
  • That means where currently tax is calculated after mortgage is deducted, with each phase, only a percentage (i.e 75% for 2017 to 2018) is deductable, whilst the other part of the mortgage (i.e 25% in 2017) is charged at basic rate tax of 20%.

In most cases, expenses are ground rents, service charges and insurance costs. Expenses are not furniture or fittings or improvements, but from 2016 when more detail about claiming incurred cost is released, it's likely that these might be claimable.

The numbers

So before I dive into some examples there's a caveats, firstly I'm not a tax advisor or expert, so please do your own maths and consult your own financial advisers. (Also if I've got these numbers wrong, please let me know!)

The following section is more detailed than probably necessary but I promise it's worth looking at. These examples don't take into account the new 2016 expense rule of actual incurred cost. In reality when this is deducted from the rental income, it would probably reduce your tax bill slightly.

IMPORTANT: These examples are stress tested at a 5% loan interest rate.


MIReliefExample 2016NB. these examples do not account for rent increases which would of course happen. The examples assume the rent stays the same.

Let me try to explain some of this and the rest you can figure out yourselves.

The examples 1-4 are typical types of property investments done by investors in the last 5 years with figures accurate as of 2015. Examples 1-3 are typical buy to let flats and example 4 is a typical 5/6 bed HMO.

Example 1 is a very typical example of a 6/7% yielding property at a 75% LTV. Interesting to note on this one is that the eventual cashflow on this deal would become negative if you are a high rate tax payer. The effective tax increase in the 5 years would be 183%!

Example 2 is a slightly different case where the LTV has been reduced to 50%, perhaps a strategy to increase cashflow paying down older properties in a portfolio. The monthly rental does cover the mortgage payment and so there's a lot of relief on a property with this high rental value. That relief is decimated over 5 years and unbelievably this investment is the worst of the 4 examples. Effective tax increase is 286% and Net cashflow goes from profit £165 to a deficit of over £104. Changing the LTV by remortgaging wouldn't help either because the rental will only cover a borrowing of £297,600. This would be the kind of investment that landlord will probably dispose of and reinvest the capital elsewhere because no amount of re-jigging will make this deal work within the new rules.

Example 3 is a high 10% yielding deal that can be found in the North of England in places like Manchester, Liverpool, Hull, Middlesbrough etc. The numbers on this deal show that it 2020 it can still work out although profits are reduced by over 50%. It's interesting to note that because the numbers on this deal are considerably lower, the effect of the new rules don't feel as harsh, however it's important to point out that the effective tax increase is still 85%. It's likely if these types of properties are furnished, they will become unfurnished lets to reduce the risk of large expenses occurring and wiping out an entire years profits.

Example 4 is a typical HMO found in the South West of England. This is a house that's been converted to a 5/6 bed shared accommodation. There are extra costs to running an HMO that's reflected in the running costs, however there's no ground rents or service charges as these are not flats. This deal yields over 15% with a strong cashflow and is the type of deal being snapped up by savvy investors right now. The figures show that the effective tax increase on this investment is at a mere 36% compared to the other examples. This is however still dwarfed by the fact that net cashflow also reduces by £276 and that leaves a measly net cashflow of £237.50 in 2020 on a property with £3000pcm rental.

Key Points

  1. Best deal scenario still shows an effective tax increase of 36% and worst case shows a massive tax increase of 286%
  2. All cashflows are impacted by 2020. Of course these examples don't take into account rent rises.
  3. Certain deals which are typically found in most investor portfolios may no longer work and cannot be re-worked. This would lead to investors selling to recapitalize and reinvest in better deals.
  4. Even basic rate tax payers will experience some increase in tax as wear and tear allowance is replaced with actual incurred costs. For any year where there are little to no incurred costs, a basic rate taxpayer will still be paying more tax than before.
  5. Decreasing LTV doesn't affect your tax position but does increase your cashflow.

There's a lot of information on this illustration and you'll just have to spend some time looking over this to get an idea of what this policy change means to you. In fact I've already come to the conclusion that a lot of portfolio management and re-strategising is going to be required to make my own portfolio work in the future.


What can I draw from this for the future of property investing?

  • Investors are going to need to put down bigger deposits and borrow at less than 60% LTV to make good cashflow.
  • Southern England yields will make it nearly impossible to invest in, unless you are a cash buyer.
  • More investors will look at purchasing an unencumbered property. Read this article for why this will be important.
  • Investors will move from pure cashflow strategy to looking more closely at medium and long term capital gains.
  • Removal of wear & tear allowance will push landlords more towards letting properties unfurnished.
  • Rents will most definitely increase in order to compensate for these changes. The rate of increase will be greater had these changes not been made.
  • Investors with small portfolios might choose to self manage to cut out the 10% management costs.
  • HMO's become even more attractive both for renters and investors.

What's a shame about what's happening here is that although this does help the government raise finances to cut the deficit, it doesn't address the main problems in housing and in fact I believe that it is going to make it even harder for first time buyers to get on the property market.

It's been widely talked about that a lot of these extra costs will pass directly onto the renter as landlords can increase rents. There's no real cap on rent values and when this starts happening and rents start rising, all landlords will follow suit because as a landlord, who doesn't want to receive more rent. If the market forces are affecting supply and demand, then rents will rise dramatically, on top of the pressure to supply more housing.

Landlords and investors are smart people, they are entrepreneurs at heart and will find ways to mitigate these changes. they have resources at their means to help them, from property networks, advisers, investor groups and friends. Unfortunately I think the renters will be hit hardest by these changes because they do not have the resources to change with the new rules.

If the government truly wants to help people get on the property ladder, there is only one solution to it all, BUILD MORE HOUSES. Taxing private landlords more is not a solution, and only adds to the problem. For the most part the majority of private landlords provide an extremely valuable service within the property industry. Their investment means that properties get renovated, let out to responsible tenants and provides lots of welcoming homes for people to live in.

It's not all doom and gloom, in fact it's kinda rosey

Despite the outlook of this policy I just wanted to finish with the fact that property investing is still a fantastic investment vehicle. Obstacles like this new policy are just temporary and over the course of history, investors and landlords have always found new ways to work the system so that it is profitable and great investing.

I remember when I first got into investing the rates were around 5% (already discounted) and any deal that stacked up and made a positive cash flow (ie more that £1), would be a great deal to go for. Financial climates change all the time, and as professional investors you always look for the strategies that work right now for today.

There's one BIG overriding fact that makes property a no-brainer investment in the UK, and that is the fact that demand for property has outstripped supply since the 1st World War. AND, this isn't going to change because we have gone beyond being able to supply enough properties due to more people having babies, less people dying, more globalisation which means more immigration.

This all means property will always go up in value over time. You'd never be able to buy property at the low prices of a decade ago, 2 decades ago, let alone 3 decades ago.

That means for an investor starting young, you could have up to 6 or even 7 decades of unparalleled capital growth in your portfolio. Imagine what a property you buy now, would be worth in the year 2055.

Further information

If you would like to get a better understanding of how this directly affects your portfolio, please get in touch with us to discuss your future strategy.

If you would like to get a copy of this spreadsheet so you can plug your own numbers into it, please also get in touch with us.

5 Responses

  1. VAT is a 20% tax on purchases. The retailer simply passes this cost to the consumer, and then returns to 20% to HMRC. What stops landlords passing on the 40% RAT (Rental Added Tax) to tenants? The landlord could make it clear to the tenant that part of the rent is Tax to be paid to HMRC.
    • eddie
      True enough there is nothing stopping a landlord from adding all this cost to the renter and that would increase rents considerably, however, rental values in any given area are generally dictated by market forces of supply and demand, and also limited by a glass ceiling imposed by local economic conditions. A landlord that disregards these facts will end up having long voids until they realise that there are upper limits to rent and people will simply refuse to pay, and that ends up bad for the landlord either way.
  2. I may be missing something but you are showing the annual rent as monthly rent * 13 not * 12 Either way I cannot figure out your tax calculations. E.g. 2015 tax in first example is £68.83 which would start from a tax profit of £2065. Where does this come from?
    • eddie
      Good point with the rent. I've used an assumption that yearly rent is calculated on a per week basis, but in reality tenants would pay once a month regardless of whether a month contains 4 weeks or 5 weeks or somewhere in between. In reality a tenants is paying a different day rate per month based on the number of days, but that isn't how they actually pay up. I've made the changes accordingly.
    • eddie
      For the tax calculation, Total Tax 2015 at 40% is calculated as (Total Rent) - (10% wear & tear) - (ground rent+service charge per month) - (2015 mortgage tax relief) x 40%. In fact in 2015 there are quite a few expenses that can be deducted other than ground rent and service charges, but I'm keeping it simple for illustrative purposes.
  3. […] these was the reduction of mortgage tax relief (aka Clause 24) that I’ve covered in another post here. The brief summary of this means that many people who are on the low income tax bracket will be […]

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