The Budget is here again so it is time to review the effect of a further reduction in the standard rate of tax on mortgage repayments.
The MIRAS (Mortgage Interest Relief at Source) scheme allows building societies and similar bodies lending money by way of mortgage to allow for standard rate income tax relief at source, ie at the point of borrowing. This applies to loans up to the first £30,000. Mortgagors who are entitled to tax relief at rates higher than the standard rate of tax will generally have to apply for tax relief through their tax code.
In effect the MIRAS scheme means that the mortgage repayments are calculated on a net rate of interest. If the normal gross rate of interest is 10% then with basic rate tax at 27% in the £ the net rate becomes 7.30%. The annual repayments (interest and capital) on a £25,000 loan gross and net are as shown in Table 1.
All good agents and mortgage advisers know that Table 1 is not the way to market repayment mortgages. Agents in particular, when trying to persuade purchasers to increase their initial offers, need to be able to express the effect of borrowing an extra £1,000 in terms of the daily cost.
Precisely how many purchasers have raised their offers by another £1,000 in response to the agent’s persuasive “but surely you would not miss this opportunity for an extra 25 pence per day — would you?” is an unknown fact of agency life.
The effect on the repayment of a reduction in basic rate from 27% in the £ to 25% in the £ is shown in Table 3.
These figures should not be taken to be precise amounts as clearly a degree of rounding occurs but also because the way in which interest is treated can differ between one lender and another. Thus most building societies calculate interest on the balance of the mortgage outstanding at the beginning of each mortgage year and the monthly payments are assessed by dividing the annual sum by 12. A few lenders calculate the interest on the balance of the mortgage at the beginning of each mortgage month. To comply with the Consumer Credit Act 1974 lenders must advise borrowers of the actual or true rate of interest that is the annual percentage rate (APR). If costs are charged for arranging the loan and for the lender’s solicitor’s fees they have to be added to the borrowed sum before calculating the APR.
This difference of treatment accounts for the frequent difference in apparent mortgage interest rates of some of the banks and the building societies. When compared on the basis of their respective APRs, the differences may well be very marginal.
Reductions in income tax are usually welcomed by taxpayers, but before spending what appears to be a tax refund if the Chancellor reduces the basic rate and other rates the individual ought to consider not just the tax reduction but also the changes in tax allowances and the effect of the tax changes on their mortgage repayment. The final picture to those paying tax may not be as bounteous as it first appears. The mortgage position will be further complicated if mortgage rates increase by 0.5% in line with recent basic rate changes to 10.5%. On 10.5% gross or 7.875% net the result is an annual repayment of £2,317 compared with the current 7.3% at 27% in the £ of £2,205.
It is not always wise to count one’s chickens before the eggs are hatched!