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Buy-to-let mortgage interest tax relief explained

Under new rules being phased in over the next few years, landlords will progressively lose valuable tax relief on their buy-to-let mortgage costs. We explain what the changes mean for you.

In this article
What is buy-to-let mortgage interest tax relief? Landlord mortgage interest tax relief before 2017 Landlord mortgage interest tax relief in 2018/19 Landlord mortgage interest tax relief in April 2020
Can landlords incorporate to keep their mortgage interest relief? Get expert buy-to-let mortgage advice

What is buy-to-let mortgage interest tax relief?

Many landlords have to borrow money – through a buy-to-let mortgage – to start building a rental property portfolio.

Historically, there’s been a major tax advantage if you have a buy-to-let mortgage – you only need to declare rental income after you’ve paid your mortgage, which cuts your tax bill by potentially thousands of pounds. 

But since April 2017, the way landlords have to declare their rental income has started to change, meaning most will see their tax bills rise significantly.

Our video explains how buy-to-let mortgage tax relief is changing for landlords- and how much more you’ll need to pay.

 

Landlord mortgage interest tax relief before 2017

Under the old regime, you would only pay income tax on your net rental income, or profits. In other words, you'd first deduct the interest from the mortgage on your rental property, as well as any other expenses incurred throughout the year.

With the majority of landlords being on interest-only mortgages, this meant that in practice they could claim all of their mortgage repayments.

For a landlord charging £950 per month rental income, and with mortgage interest payments of £600 per month, it worked like this:

  • They earn rental income of £11,400 for the year
  • They pay mortgage interest of £7,200 for the year
  • Their taxable income is £4,200 (£11,400 - £7,200).
  • A basic-rate taxpayer would pay £840 in tax
  • A higher-rate taxpayer would pay £1,680 in tax
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Landlord mortgage interest tax relief in 2018/19

Since April 2017, the system of calculating tax bills on rental income has changed, and by April 2020, you won't be able to deduct all of your mortgage expenses from rental income to reduce your tax bill.

Instead, landlords will be given a new tax credit, which is less generous than the current regime. We've explained this below.

The government has decided to phase in the new mortgage interest rules over a four year period. You'll see the amount of mortgage interest tax relief steadily falling each year:

  • In the 2017-18 tax year, you can claim 75% of your mortgage tax relief
  • In the 2018-19 tax year, you can claim 50% of your mortgage tax relief
  • In the 2019-20 tax year, you can claim 25% of your mortgage tax relief

The table below shows how this will impact on a higher-rate taxpaying landlord receiving £950 rent a month and paying £600 towards their mortgage.  

Mortgage tax relief for property with £950 rent and £600 mortgage per month
Tax year Proportion of mortgage interest deductible under previous system Proportion of mortgage interest qualifying for 20% tax credit under new system Tax bill Post-tax and mortgage rental income
Prior to April 2017 100% 0% £1,680 £2,520
2017-18 75% 25% £2,040 £2,160
2018-19 50% 50% £2,400 £1,800
2019-20 25% 75% £2,760 £1,440
From April 2020 0% 100% £3,120 £1,080

Landlord mortgage interest tax relief in April 2020

From April 2020, landlords will no longer be able to deduct their mortgage costs from their rental income.

All of the rental income you earn will be taxable, and you'll instead receive a 20% tax credit for your mortgage interest. This means you can cut your final tax bill by 20% of your interest.

To work this out, simply multiply the mortgage interest you pay by 20%.

This new system will potentially increase your tax bill in two ways.

If you're a higher or additional-rate taxpayer, you won't get all the tax back on your mortgage repayments, as the credit only refunds tax at the basic 20% rate, rather than the top rate of tax paid.

Less obviously, you could also be forced into a higher tax bracket because you’ll need to declare the income that was used to pay the mortgage on your tax return.

This could push your total income into the higher (£45,000 in 2017-18) or additional-rate (£150,000) tax brackets, depending on your income from other sources, such as your salary or pension.

Mortgage interest tax relief in 2020: an example

Going back to our example of a landlord that charges £950 per month rental income, with mortgage interest payments of £600 per month.

  • They'll pay tax on the full £11,400 rental income they earn
  • They'll still pay £7,200 in mortgage interest
  • They'll get a tax credit of £1,440 (£7,200 x 20%)
  • A basic-rate taxpayer will pay £840 - no increase
  • A higher-rate taxpayer will pay £3,120 - double the tax

The chart below shows how this is calculated.

Can landlords incorporate to keep their mortgage interest relief?

This change in tax relief only affects private landlords - people who own their properties as individuals (or couples), rather than through a business.

In theory, by setting up a business that owns their rental properties, landlords will be able to continue to declare rental income after deducting the mortgage.

However, if you’re considering doing this is vital to research it thoroughly, as even with this tax saving you could end up far worse off.

There are a few reasons for this, but the main one is that mortgage rates for businesses are more expensive than for private landlords, which could cost more than you’d save in higher tax relief.

You'd also need to pay an extra round of stamp duty when you transfer ownership of the property to the business. You can use our calculator to work out your buy-to-let stamp duty bill.

Finally, if you incorporate your taxes will become more complex. Instead of paying income tax on your rental income, you'll need to file taxes for your business, and pay corporation tax on your profits.

To receive the rental income yourself, you'll need to pay a dividend. This will be taxed as income, but at a lower rate.

You can find out more in our guide to dividend tax.

Get expert buy-to-let mortgage advice

Before taking out a buy-to-let mortgage, it can be helpful to talk to a professional adviser. For impartial advice on the best mortgage for you from an expert who doesn't work on commission, call  Which? Mortgage Advisers on 0808 252 7987 or request a free call back using the form below.

If you'd like to talk to an expert adviser about your mortgage options, complete your details and Which? Mortgage Advisers will give you a free call back.

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Correct as of date of publication.