In today’s show, I wanted to just pause for thought a little on what we have covered so far. I thought I would add some practical application of residential mortgages, cash, BTL mortgages and bridging finance in order to get you thinking of how some of these more common financing methods could operate in your property business, perhaps in some ways you had not really considered. Interested in 100% finance, tax-free income & gains and cutting out mortgage & broker fees based on real world experience? Thought you might be!
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Transcription of the show
Hello and welcome to another episode of The Property Voice podcast. My name is Richard Brown and it’s a pleasure to have you join me on the show today.
In today’s show, I wanted to just pause for thought a little on what we have covered so far. I thought I would add some practical application of residential mortgages, cash, BTL mortgages and bridging finance in order to get you thinking of how some of these more common financing methods could operate in your property business, perhaps in some ways you had not really considered.
So let’s get practical then…
Property Chatter
So far in this third series, we have covered residential mortgages, cash, BTL & commercial mortgages and bridging finance. Today, I plan to share some practical applications mostly from my own personal experience for you to consider. Let’s start with our residential mortgage.
Residential mortgage
Earlier in the series I talked about using our home as an asset in our property investment business. We can leverage our home in a number of different ways, some of which I have done personally and will share with you in today’s episode.
First, something I have not actually done myself – consent to let. I mentioned considering using a consent to let arrangement with our residential mortgage lender instead of converting our home loan to a BTL mortgage if we wanted to rent it out. That’s a good way to get going should we want to start a rental strategy, where we let out our former home and instead buy a new home to live in. Consent to let can often be obtained on better terms than a BTL mortgage, so it is definitely worth investigating before deciding to sell your home.
This can also present us with some interesting tax benefits as I mentioned previously as well. Most notably lettings relief and an element of capital gains tax relief on any profit on a subsequent sale.
So, from something I have not actually done myself to something I definitely have: a lodger.
I have taken in lodgers into my home to convert a potential liability into an asset. Remember, Robert Kiyosaki, among others, defines an asset as something that puts money into your pocket each and every month. Our home will not do that unless we can produce a rental income.
So, on a couple of occasions I have rented out rooms in my home for rent and retained all of the rental income tax-free as those are the rules set down by HMRC. The current annual rent that you can receive tax-free is £7,500 per year, so it is now a very generous tax-free allowance…even if it means sharing a part of your home in doing so.
A simple lodger agreement or license is all you need to protect you and don’t worry, there is not the same rigmarole to evict a lodger as there is a tenant either.
Over the years, I have taken in a Monday to Friday lodger, who worked away from home during the week before going homes at weekends…neatly keeping the room available for friends and family visitors at weekends too.
I have also had a permanent lodger, renting a room at home…the ones that I have had have tended not to stay for too long as they are often in transit for some reason, such as moving home, changing job, relationship change and so on.
Finally, I have also a holiday home, which is rented out via the holiday rental portals, including Airbnb to provide additional income to support the costs of owning this property.
Whether it is long-term tenants using a consent to let, lodgers on a license agreement or short-stay guests using holiday rental sites like Airbnb, there are a number or legitimate ways to leverage our residential mortgage as a tax-efficient rental investment…at least in part.
Always makes sure you have the correct lender permissions and understand the insurance risks, whilst checking the income disclosure rules to HMRC before blindly following one of these options.
Finally, we can also use a residential mortgage to realise a tax-free capital gain under the right conditions.
In another personal example, I bought a property below market value, lived in it for a year and then sold it on at a profit. Clearly, without renting it out my investment return would have been limited to the capital growth on the property but as the full gain was capital gains tax free, being my home, the after tax position of doing this was compelling when compared to some alternative investment projects I could have undertaken instead.
It is something I have undertaken a few times now – here is an example with some headline numbers to illustrate the point.
- Home purchase £165,000
- Costs c£9,000
- Mortgage deposit c£25,000
- Total cash investment c£34,000
- Sale value £186,000
- Profit on sale £12,000 (tax-free)
- ROI 35%
Had I also taken in a lodger or something like that, the results would of course been better.
There is an obvious flaw in this idea and that is that as we are dealing with our home, we will need to either reinvest some or all of our profit into a new home or switch to renting instead to retain it. An alternative is to use this concept to continue to climb the property ladder, adding value into one property before extracting it and reinvesting in a larger property as you go. However, these practical applications to turning your home into a property development may not suit all of you and especially if you have a partner or a family.
The other potential downside is that it could be interpreted as gaming the tax system by HMRC and so it’s not something to repeat too frequently. In my own case, it suited my lifestyle to have a relatively short time living in this property after a change in my personal circumstances and so it was opportune to have an eye on the investment side of things whilst doing so.
Cash
Let’s look at a couple of real examples where I have expressly decided to use cash as a means to fund a property investment.
I am a firm believer in leverage i.e. using other people’s money such as a bank’s in order to grow my effective return on personal cash investment. However, there are some occasions where the benefits of cash have trumped the use of finance.
For example, I have agreed on a transaction a couple of years ago just before Christmas, which is a quiet time generally speaking. The vendor had had two previous sales agreed on their property and were looking to see a quick return of funds at a distinctly quiet time of year.
Being a cash buyer I was not only able to secure a discount of around 18% from comparable property values locally, but was also able to knock out some of the first time buyer competition, who all required a mortgage…the same types of buyer that caused the previous two sales to collapse in fact!
Speed and simplicity were key to securing an attractive level of discount on a deal I found from a local estate agent with very little work involved. The previous mortgage-backed purchases also gave me leverage in my negotiation.
Quite recently, I have been involved in a couple of flip transactions, which were closed in cash and once again speed was the most important criteria in securing the deal in the vendor’s mind. However, in addition, let me illustrate how using cash also helped to improve the returns on some of these lower value transactions.
Cash finance example:
- Property purchase price £72,000
- Improvement works costs & all fees c£35,000
- Total cash investment £107,000
- End Valuation c£125,000
- Net profit £18,000
- ROI 16.8%
Bridging finance equivalent
- As above aside from incremental fees arising due to bridging finance of £7,600
- Total cash investment £64,200
- Net profit £10,400
- ROI 16.2%
As I highlighted in a previous episode a couple of weeks ago, often the lower value property projects can lose a significant chunk of profit once all of the finance fees are taken into consideration, especially when some of these fees are not directly proportional to the purchase price.
Granted, in this example you could argue that with a similar ROI that we should still use the bridging finance option as we could in effect undertake nearly two projects of a similar value simultaneously and generate a higher overall cash return. However, property projects are often not as predictable as we would like and so a more certain £18k is probably a better bet than a less certain £20k just in case we hit a delay in one or both of the projects that results in increased costs of finance!
Therefore, at these lower purchase price levels, we often find that cash still offers a cost effective return whilst carrying less finance risk with it.
I think this illustrates quite well how cash can still be an effective financing tool in practical terms…less external interference, more speed, higher perceived buyer status and at the lower end of the scale similar returns but less financing risk issues too.
BTL
BTL mortgages are pretty boring in all honesty. In the past, many property investors would have taken out a vanilla BTL loan and so will be fairly familiar with them. A practical variation looking forward will be commercial BTL mortgages, should we decide to acquire investment properties through a company to avoid some of tax restrictions of investing in our personal names. That twist aside, they are broadly similar offerings for the purposes of the discussion here.
Granted there are a couple of interesting variations now on the market, such as light and heavy refurbishment BTL mortgages, where a further advance can be drawn down after improvement works have been undertaken. I have not personally undertaken one of these further advance improvement works loans, so I can’t share a practical application on these here. The main reason for me not pursuing these refurbishment loans to date is that I have found better ways to recycle my cash, which is one of my main personal investment drivers.
However, one neat practical application of using BTL mortgages that I can suggest you look into is when it comes to renewing an existing BTL mortgage, for example when the fixed rate period comes to an end or considering remortaging.
Over the past year or so, I have had the initial fixed term on several BTL mortgages come to an end. In each case, the broker that I used approached me and suggested a remortgage onto a better rate with a new lender. This would save me money on my monthly payments when compared to the standard variable reversion rate with my existing lender. However, the level of fees involved would make this saving highly questionable in reality, especially if renewing for a short period of time, like 2 or 3 years.
I think there must be a secret code between lenders and introducers, though, as in each of the last 3 renewals that I was involved with, the following sequence took place:
Around 3 months before the fixed-rate expiry, my broker would contact me and suggest an alternative mortgage rate, probably with a new lender. The result was a new application, which apart from being a bit of a hassle, also involved a new set of fees for the broker, new lender, and possibly a solicitor to handle the remortgage.
Then, around 1 month before the fixed-rate expiry, my existing lender would contact me and offer me a new loyal customer fixed rate renewal. Admittedly, it seems that the new rate from the existing lender was not always as attractive as the new best rate from the new lender proposed by my broker…but it was close. In addition to the rate being close however, there are no broker or lender renewal fees to pay and using a solicitor was purely optional as nothing had really changed since the original loan had been put in place.
So, I learned that waiting for the existing lender to come into play close to the renewal date enabled me to effectively reduce my total cost of financing when compared to switching lender. It seems that in the decision to stick or twist, sticking could help to beat the bank.
That is another practical example of how to leverage your BTL mortgage but here is another…further advance.
I have a property in Cornwall which I bought and refurbished. As it happens, I felt the original valuer had undercooked the revaluation post-works but that is another story! However, what I did want to share here was the fact that this lender was open to the idea of providing a further advance on the property after a couple of years based on their current ‘desktop valuation’!
This further advance would have been on better terms than a remortgage, would have eliminated a complex new application and would also have avoided some potential costs in the process. If I wanted to release additional funds for further portfolio expansion, I certainly could have accepted this further advance at a reasonable rate and got hold of a lump sum close to another deposit on a new investment property. Personally, I decided against accepting this to be honest, but only as I wanted to keep my average portfolio loan-to-value down at the time. That does not mean that you have to follow suit of course and so that may be an option open to you to release additional funds for expansion.
There’s around 3 different practical applications of how to leverage your BTL loans to reduce your personal cash resources, reduce hefty fees and expand your investment activities in the process!
Bridging
Kevin Wright was our last guest. He made the case for bridging finance pretty well I think. So, I just wanted to share a couple of personal examples where I have applied some of the benefits of bridging, although perhaps in less obvious ways.
How about 100% funding of the purchase price for example? I thought that may get your attention!
Kevin did mention this when we had a chat but this was in a different context, often where we gain key access a property before legal completion to undertake improvement works and then get the valuation done afterward. That is certainly a great practical application of shrinking your deposit as he described it.
In my own case, what I was secure a bridging loan on both the property I was buying but also on a second property I owned as well. In my particular case, the second property was unencumbered, which means it had no mortgage on it, so the lender was happy to take a charge on both properties and advance me a loan that allowed me to pay for my purchase 100% using the bridging loan. The reason that I decided to do this was because the level and cost of improvement works on this particular project were quite high and so having less money tied up in the property was an attractive advantage. It was not a low-value purchase and so the costs of financing did not adversely affect my net ROI after finance costs either.
Whilst I was able to offer a second property for the lender to take a charge over that had no mortgage on it, in fact, if I did have a mortgage on it this still may have been possible. However, the loan-to-value after the additional bridging loan was in place would have had to be within the lender’s acceptable limits and permission from the existing lender would also be required.
As I mentioned, I was able to keep my cash input down to a minimum for the project and so was able to leverage someone else’s money allowing me to do more with less of my own funds. This is not necessarily a beginner financing strategy, so do take the time to fully understand all that’s involved in such an undertaking.
Another application of bridging finance that I really like is to compliment what I call the BRR Strategy. BRR stands for Buy, Refurbish & Refinance and is a personal favourite.
What this means is we buy the property using bridging finance to keep our personal cash input down, then undertake improvement works to increase the property’s value, before exiting the bridging loan by taking out a BTL mortgage based on a higher revaluation once the works are completed.
The new BTL mortgage will be based on the valuation after the works have been completed and so at a higher value. The remortgage will allow the bridging loan to be repaid, some or all of the costs of undertaking the works and in certain extreme cases also provide additional cashback into our pocket for further investment too! In addition, we also have an extra property in our portfolio to generate an income and grow in value over time.
This BRR Strategy allows us to recycle our personal cash funds to enable us to buy more properties with the same starting investment fund. I normally budget on leaving in around 10% to 15% of the property revaluation in each deal and so I then seek to top up the difference through savings and rental profits ready to go again the next time. If I do manage to fully recycle my deposit on remortaging, then so much the better, as I can start my next project straight away.
Of course, you don’t have to have a bridging loan to follow this strategy, we could apply the same logic when buying in cash as well. The key is to add value through improvement works before refinancing onto a long-term financing product such as a BTL mortgage to release some or all of your starting cash investment funds.
Here is an overview of one project similar to this one.
Project in Lincolnshire
- Purchase price £142,000
- Improvement works and fees c£12,000
- Finance charges c£8,000
- Cash required £62,200
- BTL mortgage revaluation £195,000
- New loan £146,250
- Cash left in after refinancing £15,750
This is equivalent to 8% of the property’s revaluation, which compares favourably to a 25% deposit on a property bought without undertaking this BRR Strategy. It therefore allows me to leverage bridging finance and BTL mortgages in order to make my cash funds go further. In this case, I can stretch the same deposit funds by 300% by following this approach.
When you add in the relative merits of speed into the process, I think you would agree that there are several practical applications of bridging finance too.
OK, so I really wanted to pause and recap on some of the institutional financing methods that we have covered so far and apply some real-life, practical application. I hope you found some of those examples helpful. We shall continue the theme of alternative financing methods in property over the coming weeks as we bring in more guests and look to extract the practical application as we go.
As ever, please feel free to email me personally if you want to talk about anything from today’s show or more general in property investing to podcast@thepropertyvoice.net, the show notes will be over at the website www.thepropertyvoice.net
Now all that remains is to say thank you very much for listening again this week and until next time on The Property Voice Podcast…it’s ciao-ciao.