Could you please explain how changes in income tax affect mortgage repayments?
The Chancellor’s announcement of a 2p reduction in basic-rate income tax has a double effect for those taxpayers who are also home-buyers. In the first instance it increases the individual’s net of tax income but at the same time, by reducing the effective tax relief on interest, it increases the level of net annual repayments.
The overall effect of the budget changes for specific individuals are further complicated by changes in personal allowances, changes in National Insurance contributions already announced and retention of the higher-rate tax bands at their 1986 levels. For these reasons our illustrations are non-specific and simplified.
An individual with a taxable income of £15,000 and with tax at 29p in the £ would have an annual tax bill of £15,000 x 29% = £4,350. The reduction of the tax rate to 27p in the £ changes this to £15,000 x 27% = £4,050. A change of £300 a year.
A £20,000 mortgage at 12.25% over 15 years arranged under MIRAS would, as at March 1 1987, have cost:
The annual cost for the same mortgage later in this year after the tax change would become:
Unfortunately these precise percentages are not covered in any normal set of tables. Parry’s shows the figure for 8.9% for 25 years to be £0.8415 per £100. But, unabashed by the complexities of the mathematics, we will persevere.
The formula for the mortgage instalment table is:
Thus the 2p in £ tax reduction has resulted in an annual increase in the mortgage repayment of £11.69.
However, before this will take place the recently announced reduction in interest will become operative. For many this will bring the rate down to around 11.25% and the cost again readjusts to:
and substituting one gets:
£0.79487 per month per £100
£158.98 per month per £20,000
£1,907.70 per year per £20,000.
Although the average mortgage in the London area is now reported to be in the region of £40,000, there are still very many mortgages at figures substantially below £20,000. To issue notices to all borrowers initially for the change in tax and, second, for the change in interest rate would be very costly. Thus one can expect most societies to handle both changes at the same time, probably in May/June. Naturally, any interim credits that might arise and interim debits, however small, will form part of the adjustment undertaken by the societies’ computers.
Borrowers with endowment mortgages will also be notified of the changes to their interest payments. On a £20,000 sum the figures are likely to be:
£20,000 at 8.7% = £1,740
£20,000 at 8.9425% = £1,788.5
£20,000 at 8.21% = £1,642.
In these illustrations it has been assumed that interest is added on an annual basis and that monthly payments are calculated by dividing the annual sum by 12. There are, however, some banks and societies who base all their calculations on a diminishing monthly balance. In those cases, fortunately for them, computers can readily handle the computations on the basis of an effective monthly rate of interest.
