Top rate taxpayers hardest hit by buy-to-let changes

The restriction to the basic rate of tax the relief on buy-to-let financing costs will be phased in over four years, starting from April 2017.

This will force lenders to reassess their affordability calculation for buy-to-let mortgages, says Ray Boulger, senior technical manager for John Charcol.

He says most lenders currently require the rental income to be at least 125 per cent of mortgage payments, based on an interest rate of between 5 per cent and 6 per cent.

The 125 per cent cover is to allow for letting agents fees, voids and repairs etc.

For higher rate taxpayers, Mr Boulger says the cost of the additional tax will now have to be considered in as well.

He says a difficulty for lenders will be that for basic rate tax payers the Budget has changed nothing but higher rate taxpayers will see a very significant impact on their overall costs.

Mr Boulger says: “Lenders will have to balance keeping their rental calculation simple, coupled with perhaps changing it, or requiring a higher level of cover for higher rate tax payers.

“However, it seems rather counter intuitive to offer a higher mortgage for any given rental income to borrowers with a lower earned income.”

He added that phasing in the additional tax charge over four years should mean that there will be no rush by higher rate taxpayers to sell their buy-to-lets but most will want to reassess the viability of their investment.

“For higher rate taxpayers the greater the LTV of their mortgage and the lower their rental yield the more the changes will hit them and hence the more likely they will decide to sell when they deem it an appropriate time.

“Perhaps more importantly the changes will make new buy-to-let investment less attractive for higher rate taxpayers.”

The Budget changes will of course make no difference to landlords without a mortgage on their buy-to-let property, Mr Boulger notes.

However, a large proportion - probably a majority - of mortgaged buy-to-let properties will be owned by higher rate taxpayers.

As the Budget makes buy-to-let less attractive for these taxpayers, and indeed those who expect to shortly move into that tax bracket, Mr Boulger says the inevitable effect will be to reduce the supply of rental properties.

To avoid rents rising to reflect this lower supply other investors will need to fill the void and one possibility is institutional investors, he points out.

In particular, Mr Boulger notes Legal and General has said it plans to expand its investments in this sector.

One other property related issue in the Budget was the increase in the tax free limit for income from the rent a room scheme from £4,250 to £7,500.

Mr Boulger says this should encourage more people with a spare room to let it out.

It will also make it more viable for single people, or a childless couple, to buy a two or three bed property with the intention of letting out one room until they need it, he adds.

Now that much more, and all in some areas, of the lodger’s income is tax free the rent from the spare room will go a long way to paying the mortgage, he says.