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I have a mortgaged property in the UK where my family live. I still owe the bank about 80k on this property, which I repay at the rate of about 8k per year. The interest rate on this loan is about 5%. I have no other debts.

I would like to sell my mortgaged house and move to a larger property, but I would prefer not to take on additional debt to do so. The house I live in is ought to sell for around 375k. The properties I am looking at as possible purchases are in the 400-450k range.

I am fortunate enough to also own a small flat which is rented out and provides an additional income of about 8k per year after expenses for repairs etc. I own this flat outright - it is not mortgaged and has a value of roughly 130k.

There are legal fees, costs and other attendant expenses when buying and selling property in the UK. They will amount to several thousand pounds. I have the liquid assets to cover these.

If I want to move without borrowing additional money, I could sell the flat, pay off my mortgage and then use the remainder to fund the move. However, that would deprive me of the rental income from the property. Since the mortgage payments are essentially the same as that rental income, I would be no better off in terms of monthly income, but I'd have lost a significant chunk of potential retirement income.

Might I be better off keeping the flat and borrowing more money on the mortgage? How do I calculate my best course of action here?

Edit (taken from info in comment):

By way of explanation for that awful 5% rate is due to it being a very long term fixed-rate mortgage. It is due to end very soon, so I'll be shopping for a better deal as part of the move, if I choose not to pay it off.

  • What will happen when the current term ends? Does it become a variable rate mortgage? Will there be new fees and closing costs (if you were to hold onto the property)? – aparente001 Apr 13 '17 at 0:46
  • @aparente001 It becomes a variable rate mortgage. There will be no closing cost. A new mortgage normally attracts an opening fee, but these are usually not onerous. – Bob Tway Apr 13 '17 at 9:19
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When you compare the costs of paying your current mortgage with the rental income from the flat, you're not really comparing like with like. Firstly, the mortgage payments are covering both interest and capital repayments, so some of the 8k is money that is adding to your net worth.

Secondly, the value of the flat (130k) is much more than the outstanding mortgage (80k) so if you did sell the flat and pay off the mortgage, you'd have 50k left in cash that could be invested to provide an income.

The right way to compare the two options is to look at the different costs in each scenario.

Let's assume the bigger house will cost 425k as it makes the figures work out nicely.

If you buy the bigger house with a bigger mortgage, you will need to borrow 50k more so will end up with a mortgage of 130k, and you will still have the 8k/year from the flat. Depending on your other income, you might have to pay tax on the 8k/year - e.g. at 40% if you're a higher-rate taxpayer, leaving you with 4.8k/year.

If you sell the flat, you'll have no mortgage repayments to make and no income from the flat. You'll be able to exactly buy the new house outright with the 50k left over after you repay the mortgage, on top of your old house.

You'd also have to pay some costs to sell the flat that you wouldn't have to with the bigger mortgage, but you'd save on the costs of getting a new mortgage. They probably aren't the same, but let's simplify and assume they are. If anything the costs of selling the flat are likely to be higher than the mortgage costs.

Viewed like that, you should look at the actual costs to you of having a 130k mortgage, and how much of that would be interest. Given that you'll be remortgaging, at current mortgage rates, I'd expect interest would only be 2-3%, i.e around 2.5k - 4k, so significantly less than the income from the flat even after tax.

The total payment would be more because of capital repayment, but you could easily afford the cashflow difference. You can vary the term of the mortgage to control how much the capital repayment is, and you should easily be able to get a 130k mortgage on a 425k house with a very good deal.

So if your figure of 8k rent is accurate (considering void periods, costs of upkeep etc), then I think it easily makes sense to get the bigger house with the bigger mortgage.

Given the tax impact (which was pointed out in a comment), a third strategy may be even better: keep the flat, but take out a mortgage on it in exchange for a reduced mortgage on your main house. The reason for doing it that way is that you get some tax relief on the mortgage costs on an investment property as long as the income from that property is higher than the costs, whereas you don't on your primary residence. The tax relief used to just be at the same tax rate you were paying on the rental income, i.e. you could subtract the mortgage costs from the rental income when calculating tax. It's gradually being reduced so it's just basic rate tax relief (20%) even if you pay higher-rate tax, but it still could save you some money. You'd need to look at the different mortgage costs carefully, as "buy-to-let" mortgages often have higher interest rates.

  • This is basically what I've been typing up, so I'll just add here, you should get some mortgage quotes to understand the actual numbers in different scenarios, a worst-case sales figure for your current home and an expected sales figure for your current home. If you're not comfortable with the extra monthly payment amount that's fine, but if you are, you're building equity on the cheap by keeping the rental. – Hart CO Apr 12 '17 at 18:23
  • What about tax, depending on your other income, you might pay 40% tax on the 8k income from the flat, so it wouldn't offset the 6.5k interest. – davidsheldon Jun 6 '17 at 16:38
  • @davidsheldon : good point. I've edited my answer. The 6.5K figure was irrelevant anyway given the OP is definitely remortgaging (that was clarified after I wrote my answer) so I've just removed it. – GS - Apologise to Monica Jun 20 '17 at 21:08
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that would deprive me of the rental income from the property.

Yes, but you'd gain by not paying the interest on your other mortgage. So your net loss (or gain) is the rental income minus the interest you're paying on your home. From a cash flow perspective, you'd gain the difference between the rental income and your total payment.

Any excess proceeds from selling the flat and paying off the mortgage could be saved and use later to buy another rental for "retirement income". Or just invest in a retirement account and leave it alone. Selling the flat also gets rid of any extra time spent managing the property.

If you keep the flat, you'll need a mortgage of 105K to 150K plus closing costs depending on the cost of the house you buy, so your mortgage payment will increase by 25%-100%.

My fist choice would be to sell the flat and buy your new house debt-free (or with a very small mortgage). You're only making 6% on it, and your mortgage payment is going to be higher since you'll need to borrow about 160k if you want to keep the flat and buy a $450K house, so you're no longer cash-flow neutral. Then start saving like mad for a different rental property, or in non-real estate retirement investments.

  • In the U.S. there is a tax advantage to having a mortgage (in the early years). Is there in the UK? – aparente001 Apr 13 '17 at 0:43
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It depends what rate mortgage you can get for any extra loans...

If you remortgage you are likely to get a rate of 3.5-4%... depending who you go with.

With deposit accounts in the UK maying around 1% (yes, you can get more by tying it up for longer but not a huge amount more) clearly you're better off not having a mortgage rather than money in the bank.

Does your 8k income allow for tax? If it does, you are getting 6% return on the money tied up in the flat.

If you are getting 6% after tax on the invested money, that's way better than you would get on any left over cash paid into an investment. Borrowing money on a mortgage would cost you less than 6%... so you are better off borrowing rather than selling the flat.

If you are getting 6% before tax... depending on your tax rate... it probably makes very little difference. You'd need to work out how much an extra 80k mortgage would cost you, how much the 50k on deposit would earn you and how much you make after tax.

There is a different route. Set up a mortgage on the rental flat. You can claim the interest payment off the flat's income... reduce your tax bill so the effective mortgage rate on the flat would be less than what you could get with a mortgage on the new house. Use the money from the flat's mortgage to finance the difference in house price. In fact from a tax view, you may be better off having a mortgage free house and maxing out the mortgage on the flat so you can write off as much as possible against your tax bill.

All of the above assume ... that the flat is rented all the time. The odd dry spell on the flat could influence the sums a lot. All of the above assume that your cash flow works whichever route you choose.

As no-one on stack exchange has all of the numbers for your specific circumstances it may be worth talking to a tax accountant. They could advise you properly, knowing the numbers, which makes the best sense for you in terms of overall cost, cash flow, risk and so on.

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It is a lot easier to make money when you are not in debt. If you can sell the apartment, get rid of your existing mortgage and buy the new house outright, that is probably the best course of action.

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    What's the justification for your assertion in the first sentence? – xiaomy Apr 12 '17 at 18:05
  • @xiaomy An old Japanese aphorism. – Five Bagger Apr 12 '17 at 18:33
  • I am guessing most corporate CFO's don't share that view in today's economy, not to mention the size of Japan's public debt is second to none. – xiaomy Apr 12 '17 at 19:30
  • @xiaomy There are people who borrow money and those who lend it. Guess which ones are the rich ones. – Five Bagger Apr 12 '17 at 20:23
  • The rich knows when to borrow and what to do. – xiaomy Apr 12 '17 at 20:55

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