A common misconception we come across is property owners thinking that their total mortgage payments are tax deductible. Only the interest part of your mortgage payment is allowable for tax. The capital part is paying off your original investment so is not allowable. Why is this an issue? Well some landlords have a strategy of paying off their mortgages quicker so they can get better cash flow from their investment. This is can be a great strategy but only if you ensure that you have taken into consideration the tax impact. However, if your rental income only just covers your mortgage payments then you could end up in a negative cash flow. Let me explain. Let's say you buy a property for £125,000 and borrow 75% LTV = £93,750. Interest is 3.99% and you take the mortgage out over 15 years. You get net rental income of £750 per month, which covers your mortgage payments of £693 per month. So, ignoring any other outgoings, you have a positive cash flow of £57 per month. Good or not good? Not good. Here's the reason why.
You can only offset the interest part of the mortgage for tax purposes. In the first year the interest is £3,656. You have rental income of £750 x 12= £9,000, resulting in a taxable profit of £5,344. So if tax is 20% you pay tax of £1,069. But your positive cashflow of of £57 x 12 is only £684 so you are worse off by £385 per year! Over 15 years the figures look like this;
|Mortgage payments||Rent||Interest||Profit||Tax||Cash In/(Out)|