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Landlords are always looking at ways to make more money from their rental property but will paying down the buy-to-let mortgage or switching to a holiday let lead to better profits?
The dream for many landlords is to own a property mortgage free, but the only way to reach that happy day is to dig deep into savings or divert cash from rents or other income.
The other option is to gamble on the boom in UK tourism as the COVID 19 pandemic quarantine rules curb foreign travel.
The logic behind paying down a mortgage is straightforward. If the interest rate paid on cash in the bank is lower than the mortgage rate, then taking money out of savings to reduce a mortgage makes financial sense. The gain of lowering mortgage payments will offset any meagre return generated from banks or building society interest.
With interest from savings at rock bottom, finding somewhere to deposit cash that pays more than lenders charge for buy to let borrowing is almost impossible. The best rates are paid by fixed-rate accounts, which means tying up your savings for up to three years.
The average easy access saving account rate is around 0.23% (October 2020), while fixed rates are a little higher, averaging 0.68%, according to independent financial monitor Moneyfacts.
However, some other factors may impact the decision. Making the right financial decision often looks easy but becomes more complicated when looking at your broader financial position.
Money in the bank during these uncertain times is a helpful backup should you have a spending emergency. Once a mortgage lender has your money, you may face a problem if you need some back from a remortgage or further advance – and the exercise will cost you money in fees.
Sometimes a mortgage is a honey trap, and reducing the balance comes at a cost. Many lenders only let you pay 10% of the balance each year without triggering charges. It’s a good idea to check the small print of the mortgage terms to confirm how much you can pay off and how much the payment might cost.
Your buy-to-let mortgage repayments may stack up on paper, but they are probably the debts with the cheapest interest rates. Credit cards, personal loans and overdrafts cost a lot more to service. Consider paying other debts first, as this will save you more than reducing a mortgage.
Although savings accounts pay low interest rates, other investments can garner higher returns depending on your age and financial status. Saving into a pension comes with attractive tax relief, providing you do not need the money until you are 55 years old – or 57 from 2028.
The Seed Enterprise Investment Scheme, stocks and shares or even cryptocurrency are other options that offer higher returns if you are prepared to take the risk of losing your nest egg.
Holiday lets are bang on trend as coronavirus decimates foreign travel, and holidaymakers are looking to spend more time on breaks in the UK.
Wealthy buyers are snapping up holiday homes for cash in some of the more picturesque areas of the country, like Snowdonia, the Lake District and Cornwall. Switching a buy to let to a holiday also comes with financial and tax perks. A rule of thumb is a holiday let attracts a weekly rent in peak season that is double the monthly buy-to-let rent. This sounds great, but don’t forget the holiday season generally runs for around 16 weeks from Easter to the school half term in October and not all that time is at peak rates. You may also pick up some extra bookings for Christmas and New Year.
For an idea of how much a holiday let could earn, try this online calculator provided by rental firm Sykes Holiday Cottages. The extra income comes at a price. Holiday lets need more management and upkeep. Changeover days come with a lot of cleaning and changing bed linen. And there’s the gardening and maintenance.
Many landlords outsource these tasks, but that comes at a cost that can eat into profits. Another hidden cost is transferring the day-to-day bills from a buy-to-let tenant to yourself. These costs include business rates, utility bills, satellite TV, broadband and extra insurance.
Persuading a lender to finance a holiday let is more complex than raising money for a residential or buy-to-let mortgage. The lender will want to see that your monthly income is enough to cover all your borrowing, not just the holiday let mortgage.
Many landlords buy holiday lets with cash raised from a pension or home because the transaction is easier and cheaper than direct finance. Specialist lenders offer nearly 40 different holiday let deals, including the Cumberland, Furness, Leeds, Vernon, Melton, Mansfield, Monmouthshire, Principality, Scottish, and Yorkshire building societies.
Paying off a buy-to-let mortgage or switching the property to a holiday let is all about making more of a landlord’s investment. Many buy-to-lets are in places unsuitable for tourists so that they won’t cut it as a holiday home. For landlords tempted to change their business model, here are some answers to their most asked questions.
Holiday lets are treated as businesses for tax. The rules relating to tax credits for mortgage interest relief do not apply, and general business expenses and capital allowances can be claimed to reduce tax bills. Holiday let disposals also attract reduced capital gains tax as Entrepreneur’s Relief.
No. Landlords must comply with special rules based on the number of days each year a property is available for let and the time let to be considered as a holiday let. If the property does not pass these tests, the tax perks do not apply.
For more information, check out online guidance from HM Revenue & Customs
It’s possible to cut your buy-to-let mortgage rate by reducing the loan balance if the amount you put in moves the deal into a lower loan-to-value band.
For example, Coventry Building Society offers a 75% LTV fix until July 2026 at 3.09%, reducing to 2.09% over the same term for a 65% LTV loan. In financial terms, the mortgage is cut by a third by reducing the loan from £150,000 (75% LTV) on a £200,000 buy to let to £130,000 (65% LTV) by injecting an extra £20,000 cash.
We have a buy to let mortgage advisor on the website which Guild subscribers can contact.