To rent or not to rent?

PERSONAL FINANCE:For homeowners looking for more space but unable to take on a second mortgage, renting out their home and letting another property might be an option – but what are the possible pitfalls of such a move?

DOES THIS sound familiar? You have a growing family and need more space. But while property prices may have crashed, your own property is dwindling in negative equity, you don’t have sufficient savings to pay the mortgage and, with the uncertain economic environment, you’re hesitant in any case to commit to another mortgage. What can you do?

A growing trend is to rent your “principal private residence”(PPR), and rent another more suitable property for your family. But how does this work in practice; will it affect your beloved tracker mortgage; and what are the tax implications of such a move? Does it make financial sense?

The first thing to do is to examine how much switching home is likely to cost you. Take for example, someone who paid €395,000 for a two-bedroom Dublin home in 2006. Now with a family of four, the person has tried to sell their home – but doing so would leave them bundled with about €100,000 of negative equity. So instead they are looking to rent a four-bed property, for which they could expect to pay between about €1,500 to €2,500 a month, depending on location.

With a mortgage of €360,000, monthly repayments currently come in at about €1,330, based on a tracker of 2 per cent over 30 years. The person is unlikely to get this much if they rent out the property – €1,000 to €1,100 is possible, which would leave a shortfall of upwards of €400 a month. If they can afford to pay this extra €400-plus a month to enable them to live in a bigger house, it could significantly improve their quality of life.

Of possible concern, however, are rising interest rates. While rents are likely to remain somewhat stable over the near term, interest rates could jump, leaving the homeowner more exposed on covering their mortgage each month. For example, a 1 per cent jump in rates could push the shortfall up to €600 a month. And with a 30-year mortgage, there is less flexibility on extending the term. Moreover, tax issues also arise, which will reduce the monthly rental income, while there is also the fear that the person may encounter difficulties renting out their own home.

WHAT ABOUT MYtracker? If you have a cherished tracker mortgage, you will most likely be loathe to give this up under most circumstances – and it may actually affect your decision to trade up. But will you lose it anyway if you rent out your home? After all, you are effectively changing the terms of your mortgage. While you will have to change your home insurance policy to one that covers having tenants, whether or not you have to inform your bank that you no longer live there is another issue, and the answer is likely to depend on the terms and conditions of your own mortgage contract as well as the attitude of your individual lender.

According to Bank of Ireland, for example, in circumstances whereby a borrower rents out their PPR, the mortgage customer can still remain on their tracker rate unless they choose to move to a different product.

What about tax? When considering making such a move, of primary concern are the possible tax implications. Firstly, you might be opening yourself up to a clawback of stamp duty, depending on when you originally purchased the property as an owner-occupier. Since 2008, a clawback period of just two years applies, which means that if, as a first-time buyer, you originally paid no stamp duty on your property purchase but you are looking to rent it within two years of the purchase, you will have to cough up the stamp duty charge to Revenue. On the other hand, if you own the property for longer than two years, no clawback will apply.

The second tax implication is that, while normally, you pay no capital gains tax (CGT) at 25 per cent on any profit you make on the sale of a PPR, by renting it you may lose this exemption as you will only be eligible for partial relief for the period in which it was your primary residence. Given the current direction of property prices, making a profit on any future sale may not be of primary concern for many, but in the long term, it might be a factor.

Another issue is that, by renting out your home, you will no longer be able to claim any owner-occupier mortgage interest tax relief. Given that last year’s Finance Act extended the eligibility period until 2017 for those taking out mortgages between 2004 and 2011, this may be a significant loss, although the relief is due to be phased out completely by 2017. However, if you are on a tracker, paying low rates of interest, the value of the relief may not be that significant.

Of course, any rental income generated on the property is liable to income tax, although there are certain expenses that can be deducted against this, such as mortgage interest and management fees.

While there are also additional costs associated with renting, such as registering with the Private Residential Tenancies Board (PRTB), which costs €70, as a tenant you will also be eligible for rent relief of up to €800 a year for a married couple.

A final point to note is that the forthcoming Budget may introduce further tax changes that may either enhance, or reduce, the attractiveness of renting out your own home.

Rather than stare into a crystal ball to try and divine what the Minister for Finance might have up his sleeve, the best advice is probably to sit tight for five more weeks after which you can take the next steprs aremed with the knowledge of what is coming down the tracks, for good or ill.