Should I sell my home in negative equity or keep it and rent it out?

[Brendan Burgess]

Although each case is different, this post attempts to set out a framework for approaching this question.


The main factors to consider
The annual net profitability of keeping the house
The future profitability given the outlook for interest rates and rents
Your personal cash flow
The outlook for house prices
Your overall borrowing, exposure to property and the level of risk
The hassle of being a landlord

Note: The lender may refuse to allow you to sell it unless you can repay the shortfall between the mortgage and the sales proceeds
Lenders will usually ask you to show how you can repay the shortfall after the house is sold. In most cases they have been refusing to allow the sale. However, in some cases they have been converting the shortfall into a personal loan at the mortgage rate. Discussed further in this post.

The annual net profitability of the investment at present
Assume a property worth €200k today with a €300k mortgage on a tracker of ECB +1%. Assume that ECB rates will rise to 2% by the end of the year, so the actual interest rate will be 3%. It is assumed that the lender will allow you sell it and will give you a loan for the shortfall at the same rate. It is also assumed that you will be able to keep your cheap tracker if you rent out the property.

| Keep property| Sell it
Rental profit before interest|€12k|0
Mortgage interest at 3%|€9k|€3k
Tax|€2k|
Net profit(loss)after tax|€1k|-€3k

Because you have a cheap mortgage, you are actually €4k a year better off by not selling the house.

In calculating the profit, only deduct the interest you are paying and not the full repayments which include capital. Capital repayments are a form of saving.

If you sell your home, you will have to come to some agreement with the lender over the shortfall. If you have the cash to pay off the shortfall, you will lose the interest you would have otherwise earned on that cash.

If you lose your cheap tracker, then the balance swings in favour of selling the house
The above example assumes that you can keep your cheap tracker. However, some mortgage agreements specifically state that the cheap tracker only applies while it is your home. If you rent it out, you go to the standard variable rate for investment properties which is far higher. This is discussed further here.

The future profitability
It’s very hard to predict interest rates, but you probably should allow for a long term interest rate of 4% i.e. ECB +3%. Such a rise would wipe out most of the profit you get by holding onto the property.

Are you sure you can get a good tenant who will pay the rent? But what if you can’t rent the place or what if your tenant can’t or won’t pay the rent?

Your personal cash flow
Although keeping the property is profitable on an “accounting” basis, if you cannot afford the mortgage repayments, then you may have to sell the property anyway. You have to do the arithmetic

| Keep property| Sell it
Rental profit before interest|€12k|0
Mortgage repayments|€20k|€6.6k
Tax|€2k|
Net outgoings after tax|€10k|€6.6k

Selling will improve your cash flow by €3,400 per annum.

The outlook for property prices
We don’t speculate about house prices on askaboutmoney. You are making a net return of around 2% a year through rental profit at the moment. But if you think that property prices in your area are going to fall by more than 2% a year, then you should sell.


The hassle of renting
Some people are natural landlords and are good at it. However, if dealing with tenants would drive you crazy then this may well be a decisive factor encouraging you to sell.

 

[Brendan Burgess]

Other factors which may influence the decision

Your overall borrowing, exposure to property and the level of risk
The above example looks at a single property in isolation. If you have an investment property, then maybe you are overexposed to property price falls and interest rate rises.

However, it could be argued that if you are in severe negative equity on your home and your investment, the only route to solvency is if house prices rise. So selling won’t help you.


If you have a cheap tracker, you may be able to get a discount by paying it off early.
There is no hard evidence yet that lenders are doing deals with borrowers to get them off trackers. (Discussed further in this post)But this may happen in the near future. Go talk to them before doing anything. If you have to move, don’t tell the lender that. Say to them - “I am thinking of selling my property and renting as I can’t afford the repayments. If I do sell, will you accept the proceeds in full settlement of the mortgage?”


You may need the house again at some stage in the future
This used to be a significant issue when stamp duties were as high as 9%. It’s less of an issue now.

But if you are considering selling because you are moving in with your partner or because you are relocating for a new job, then maybe it’s worth keeping the house as an investment until you see how things work out.

Some people have suggested considering using the Rent a Room Scheme instead of letting the house
This way you keep a room available for yourself to use.
You keep the tracker rate.
You don't have the hassle of the PTRB

 

[Gekko]

The interest deduction is currently restricted to 75% of the interest. It's thought that this may decrease, but that's merely speculation. That would impact on the calculations.

 

[Brendan Burgess]

Hi Gekko

I had factored this in and rounded the figures.

Profit: 12k
Interest allowed: 6.75k
Profit:5.25
Tax 2.8 (for a top rate tax payer)

Which I rounded down to 2, instead of up to 3.

But as all the figures are estimates, it's not really material.

The key point is that based on these figures, the person is making more money by holding on to it than by selling it.

 

[Gekko]

Hi Brendan

Is it also worth considering the retention of the property in the context of pension planning?

Take a 2 bedroom apartment that's generating rent of €12,000 per annum. For a pensioner, this would be useful income and they'd have something to pass to their offspring (which they wouldn't with, say, an annuity).

Given the far less generous tax rules in relation to pensions, perhaps aiming for such "pension income" wouldn't be the worst (or most costly) option in the world? I've obviously ignored inflation in relation to the €12,000.

 

[Brendan Burgess]

Hi Gekko

I have seen so many people who invested in property as "their pension" that I recoil in shock whenever I see the two words in the same sentence. In fact, an earlier version of my post had a section "common misunderstandings" which featured "I will keep the property as my pension".

The main prioirty for someone in negative equity is to reduce that negative equity as quickly as possible. When the mortgage is less than the value of the house, they are free to sell it without having to get the permission of the lender.

When they get rid of the negative equity, they can review the strategy. Is it right to sell? Is it a good long term investment? Are they better off using any spare cash to reduce the mortgage or maybe to contribute to a pension fund.

By the time most people who are currently in negative equity have it paid off, the pensions tax breaks will probably be so diluted, that they would indeed be better off paying down their mortgage than contributing to a pension.

Brendan

 

[Gekko]

I agree 100% that many people are overexposed to property in relation to their pensions. It's okay for property to play some part in an individual's portfolio though. I'd be looking at the maths of funding (say) €12,000 per annum, the inheritance tax consequences, diversification etc. The answer may still be to dump the property as soon as the negative equity's eliminated, but I'd consider all angles, especially as pension funding becomes more difficult due to draconian changes in tax policy.