Financing Your Holiday Home
Setting things up correctly can save £1,000s over time
It’s been a strong year for sales of holiday cottages in Cornwall and I have had many conversations with potential owners looking for the best way to finance their property. Some are lucky enough to have the cash to fund the entire purchase but even then it isn’t a foregone conclusion that being mortgage free on your holiday business is the most efficient way to arrange things.
I haven’t practiced as a financial advisor for some time but I do keep in touch with my former colleagues and try to keep up with the state of the mortgage market so I’m able to help my owners where I can. Whilst the number of lenders who specialise in holiday home lending remains limited, we are seeing a lot more flexibility from lenders who allow clients to remortgage their current property to place a deposit towards or completely purchase an investment property. Furthermore, lenders are also far more flexible when lending for a second home and will allow occasional holiday letting using residential rates if you want the best of both worlds (letting income and use of the property).
Up to 75% of a holiday property is typically available and the loan will either be based on a client’s income or the income potential for the property. If you are basing the loan on the property’s income potential, lenders will use their own stress testing for justifying a loan and this ranges from 125 -200% of the annual mortgage interest. It’s interesting to note that most lenders work on gross rental income and given that a large chunk of this is taken up with the expenses of running a holiday home the calculation can actually be very reasonable compared to a normal buy to let.
Recent reforms to pensions have seen lenders become more flexible when lending to older clients. In the past loans had to be repaid by state retirement age but it’s now possible to run loans up to age 75 and some have even removed their upper age limit altogether to gain market advantage.
Whilst lenders aren’t allowed to place adverts in The Press stating they have loads of money to lend and not enough clients, an awful lot of them are cash rich or have too many traditional mortgages on their books and need to lend more in the investment sector to balance their risk books. Now is definitely a good time to be looking for a loan as interest rates are not tipped to rise until the end of 2017 and this definitely benefits borrowers over savers.
Arranging Loans For maximum Tax Efficiency
The simple rule of thumb here is that if you have borrowing on either your holiday home or you main residence you should maximise the borrowing on the holiday home as this will be allowable against tax. Note that the forthcoming restrictions on buy to let interest relief do not apply to holiday homes that exceed the availability & occupancy thresholds (210 & 105 days respectively). Even if this means that the business makes a loss you should still maximise this as losses are not lost- they carry forward forever and at some point should deliver a tax free income. See my previous article ‘Losses are not Lost’ at blog.abovebeachcottages.co.uk.
If the rate available to you on your residence is lower than that on the holiday home you’ll need to take this into account but the tax relief will normally more than make up for this especially for higher rate taxpayers. Put simply you should borrow as much as possible against your holiday home and pay off your residential mortgage with any surplus. Note that you can do this even if you have owned the holiday home for years as effectively you are paying yourself back the capital you invested in the first place so the loan will qualify.
Borrowing deposits or full finance against your main residence.
It’s fine if this is the only way for you to fund the purchase as long as you arrange things carefully at the start. Ideally leave the money raised by the additional loan in your solicitors client account and use it for the purchase straight from there. This will provide cast iron evidence that the funding was for your holiday home and you’ll get tax relief on the proportion of interest relating to it.
A Special Trick If You Already Have The Deposit
Let’s imagine you have £150,000 in the bank- perhaps you have received a legacy or sold another property and you also have a £250,000 mortgage on your residence. If you are planning to use the money as a deposit for a holiday home then make arrangements with your lender to pay down your mortgage then borrow the money back or pay off the mortgage and take out a new one if you can get a better rate. This means that the interest on the £150k on your residence now qualifies for tax relief- for a higher rate taxpayer paying 4% interest that’s worth £2,400 a year.