Interest Only Mortgage - Flaw ?

Hi
Can someone please point out if they see any flaw in the following ?
I have an investment property for which I have a mortgage of 135,000 euro. I have rented this out and the property is basically paying for itself. It is now worth about 240,000 euro.
I am thinking of increasing the mortgage to 165,000 to pay for some home improvements to my main residence. I am considering getting an interest only mortgage over 25 years. The rent received will be about 400 euro greater than the monthly interest, so I will have an extra 400 euro in my pocket (which will come in very handy at the moment). Then in 25 years time, I will sell the property to one of my daughters for 165,000 euro. So at that stage, I will pay off the principal amount, and my daughter will have a property of her own with a mortgage of a mere 165,000 euro.
This seems to me to be a win-win situation for both myself and my daughter.
Am I missing anything in my reasoning ?

All comments appreciated.

Kevin

Tax on rental income?

CGT on disposal?

How certain are you that your daughter will want to, and/or will be in a position to, buy this property in 25 years time. 25 years is a long, long time away.

"Tax on rental income?" - yes, but I'm paying this tax already. I can live with this.

"CGT on disposal?" !!! - I bought the property for 125,000 euro, I will be selling it for 165,000 euro in 25 years time. CGT is not really an issue.

Your point querying my daughter's intentions in 25 years time is not really an issue either. I have 2 daughters - if on the small chance none of them want it, then I can just sell the property.

What I am trying to do is make some money from the house every month for living expenses, and also hopefully give one of my children a foothold on the property ladder.

Apart from these points, is this a route which people woul recommend ?

kevinf said:

"CGT on disposal?" !!! - I bought the property for 125,000 euro, I will be selling it for 165,000 euro in 25 years time. CGT is not really an issue.

Click to expand...

not 100% sure kevinf but isn't CGT calculated at market value so market value in 25 yrs time - 125,000 paid. I don't think it would be based on the 165,000 selling price?

thats right dillons...cgt is calculated at market value so if house is worth 300,000 in 25 years and u sell it for 165,000...cgt is calculated on 300,000

The obivious flaw is the price you sell at in 25 years time.
Granted it will pay of the mortgage (assuming thats your ultimate and only goal then makes sense)

But as an investment? No its not good at all.
You €135,000 paid and in 25 years time you'll get €165,000. Thats not an investment. In real world that is actually a loss. Inflation figure at just 3% alone will kill your €165,000 in just 7 years and you will have another
18 years to go.

Take your point on rent v mortgage difference but you should save this difference to finance upgrade and definatley consider selling in 25 years time at a higher price closer in keeping track with inflation.
IT would still be low price for your daughter but would also be more of a win situation for yourself as well.

If interest rates rise over the next 25 years your rental profit decreases. ie you dont necessarily make 400 euro a month.

Based on the CGT responses above would it be a better idea to sell at say 300,000 (then market value), pay off your mortgage and share the profit between your daughters. Maybe on the understanding that they use it for a house deposit.

I appreciate that handing over a house would be more desirable. Either way its a great thing you're trying to do for them, they are lucky girls.

cas.

Hi Confusion.

Can you please clarify what you said in the last paragraph, I'm a bit confused ?

Maybe I didn't express myself better in my original post. What I was hoping to do was to 'give' this house to my daughter in 25 years, and hopefully make some money out of it (from the rental income) in the intervening period. I realise that this is not a good investment for myself but that is not my goal.

If the interest only mortgage, and subsequent sale to my daughter (which will mean large CGT) is not a good idea, then can you suggest something else ?
Should I just continue with a normal mortgage, and gift the house to my daughter in 25 years, or is that another inefficient approach ?

Sorry if I seem a bit green, and thanks to everybody for replying so far.

Kevin

Kevinf,

135K - 165K is 35K profit
What I was saying that if inflation were running at 3% per year it would eat this profit in approx 7 years, so in actual terms you would make a loss.
In other words a euro today will buy more than 25 years time.
That said, the above is not you goal. (Understandable as you wish to set up your daughter) With that in mind see below.


Yes, you could gift the house to your daughter. A gift of €478,155K after indexation is allowed to your daughter (2006 figures). GCT still payable though as not your Primary residence.

Simply no way around you paying not GCT (at market value in 25 years when selling) and then clawing back this payment from your daughters.

Property in ireland since 80's has doubled every 7 years (crash would eliminate one of these doubles) so in 25 years time the property realistically could be worth circa 450K (going on historical trend although we dont have crystal ball).

450K – 165K (outstanding mortgage) is 285K – 24K allowance, is roughly 52K CGT, then daughters mortgage is 217K (165+52cgt)

Better if you start paying off some of the outstanding mortgage now.
Say you paid 65K off mortgage
450 – 100 (outstanding) = 350K – 24K allowance then 65 CGT,
then daughters mortgage is (100K + 65K) = 165K

She’d pay more capital gains an extra 13K for you, but her mortgage would be lowered by 52K.

Thanks again Confusion.
Actually I understand that part about inflation at 3% per year eating up the profit in 7 years. The bit I wasn't sure about was
"Take your point on rent v mortgage difference but you should save this difference to finance upgrade and definatley consider selling in 25 years time at a higher price closer in keeping track with inflation."

Anyway I see that there is to way of not paying CGT in 25 years time.
I follow the 2 scenarios you posted below. You stated
"Better if you start paying off some of the outstanding mortgage now"
I don't think that that is right.
In that case my daughter pays 13K more CGT but her mortgage is lower by 52K. So she is 39K better off but I am 65K worse off !
(ok she does better but am I not paying too much to ensure that ?)

The other way around, I save paying off the 65K, and she is 39K worse off. But that is 39K in 25 yrs time which should not be too much of an additional burden.

Am I missing something here ?

Kevin

It's very hard to answer this as the logic is very flawed indeed. You are mixing up lots of different unconnected issues. It's very difficult to know where to start. I think it's best to start again and deal with the issues one at a time.

1) You have a property worth €240k. You have a mortgage of €135k.

Should you convert this mortgage into an interest only mortgage?
Yes you should, as you get tax relief on the interest part of the repayment. As you make capital repayments, you will be paying less interest and so you will be getting tax relief.

2) You want to borrow €30k to improve your home.
Should you borrow this on an interest only basis?
Should you add this to your investment property mortgage?

The answer to both questions is no. You get very limited interest relief on the interest on a loan used to buy or improve your home, so you should pay this off as quickly as possible.

I am assuming that you have a mortgage on your home already which you can extend by €30k. You should always pay this mortgage off before making any capital repayments on your investment mortgage.

General point
There is no connection between the three issues:
Investment property
€30k needed to improve your home
Your plan to give the house to your daughter.

If the investment property is a good investment, it is a good investment.
If you want to spend €30k on your home, do so.
It's a nice idea to give your daughter a home at a low price.

By discussing the three topics together, you are confusing yourself.

Brendan

kevinf said:

I follow the 2 scenarios you posted below. You stated
"Better if you start paying off some of the outstanding mortgage now"
I don't think that that is right.
In that case my daughter pays 13K more CGT but her mortgage is lower by 52K. So she is 39K better off but I am 65K worse off !
(ok she does better but am I not paying too much to ensure that ?)

The other way around, I save paying off the 65K, and she is 39K worse off. But that is 39K in 25 yrs time which should not be too much of an additional burden.

Am I missing something here ?

Kevin

Click to expand...

Yes on the face of it you'd be 65K down, but you'd get better Tax relief on normal (single about 64 per month married 128 approx) that would mean you'd have to earn roughily 256 to get 128 after tax.

Anyway the tax relief (married) would add up to apporx 38,000 after 25 years (without indexation of course).
65K -38K is 27 K you are out of pocket, but she is 39k to good scenario 2, so daughter could pay and she'd be better off by, 12K, and you'd still be the same as scenerio 1

But thats not even taking into account the savings you'd make on interest payments, which would put you in a better position in long run over the 25 years.

To Brendan

With all due respect, you're answering questions which I did not ask.
You're making some assumptions which are not valid in my case.
I stated in my original post that I was going to add 30K to my investment mortgage - you're making the assumption that I can add this to my main residence mortgage. For various reasons I cannot do this.

So, the bottom line is that I will be adding 30K to my investment mortgage.
I plan to give/sell this house to my daughter in 25 years, so I was wondering if it was better to transfer the mortgage to an interest only mortgage ?
This is my only question.

I'm not "confusing myself", maybe I was not specific enough in my original post.
Any further comments appreciated.

Kevin

To Confusion

Thank you for responding again. However I still don't understand you. You have trotted out a lot of figures which are more confusing than enlightening. You seem to be saying that paying 65K of the principal on my investment mortgage is really only costing me 27K !
If you have time, can you please do the calculations in a logical fashion ?
I admit I’m a bit green when it comes to property and mortgages but I’m fairly confident that I can follow the mathematics side of it.

Thanks again.

Kevin

Kevin

There is no point in answering the questions you asked as you are not asking the right questions.

You have to take the issues one at a time.

1) You need €30k to improve your home.

2) You cannot borrow this on your home mortgage.

3) You are going to secure this loan on your investment property.

4) You cannot set the interest on this extra loan against your rental income as it was not borrowed to buy or improve the investment property.

5) You can get the much lower tax relief payable on money borrowed to buy or improve your home.

6)You should switch the existing investment mortgage to interest only.

7)You should pay off the extra loan first as the tax relief is a lot less.

8) What you do with the house in 25 years is irrelevant and only confuses the issue.

Brendan

Thank you for that response. I'm a lot wiser now !
Sorry for the delay in replying - I thought that after a week or so of no responses from anybody that it was finished.

Kevin