1 August 2023

Mortgages for Overseas Buyers of UK Residential Property – The Advantages and Disadvantages

We are often asked by overseas clients buying UK property whether or not they should take out a loan secured against the house or flat they are buying. Quite often buyers have the financial means to complete the purchase without a loan of any kind but nevertheless there are good reasons why they might wish to consider taking out a loan.

In fact, it is increasingly common for overseas buyers to take out mortgages and it is now less likely that they would wish to purchase for cash than was the case a few years ago.

We summarise here the principal considerations to take into account and to outline the possible advantages and disadvantages of taking out a loan.

Types of mortgages

There are clearly a huge variety and number of financial products potentially available to overseas buyers. These are likely to be different products, and perhaps at less advantageous rates, than those available to UK resident buyers who wish to purchase a property as their principal residence. The first consideration is whether the loan will be to an owner-occupier or whether it will be for the purposes of buying an investment property that will be let. The rates available to owner- occupiers are generally better than those available to buyto-let purchasers and it is likely the bank or lender will offer entirely different products in each category. The loan to value ratios are likely to be different and for buy-to-let might be only 50% or 60% of the market value of the property.

Traditional mortgages are secured by a first legal charge over the property being acquired. The mortgage deed under which this is created is relatively straightforward and will refer to a set of mortgage conditions, which tend to be fairly standard, drawn up the lender. More recently a different type of mortgage product has emerged arising from religious considerations particularly those relating to Islamic law. The traditional type of mortgage may not be acceptable for religious reasons and, as a result, a number of alternatives have been drawn up which, for example, create lease and rental agreements so that interest is not payable to the bank. Some lenders only offer Sharia compliant finance and their products are therefore available not just to Muslims but to all applicants.

UK tax considerations

UK Inheritance Tax (“IHT”)

It is likely to be beneficial for IHT reasons for an overseas buyer to take out a mortgage when buying a UK property. IHT is payable at a rate of 40% on the value of assets situated in the UK worth over £325,000 (the “nil-rate band”). A mortgage which is taken out at the time of purchase is deductible against the value of the property. Therefore, taking a loan of, say, 60% of the value of the property could reduce the exposure to IHT considerably. The following example illustrates the differing IHT treatment for an overseas owner with only one asset in the UK, a property valued at £1 million at the date of death, which was purchased for £800,000:

IHT without mortgage IHT with 60% mortgage

Gross value at date of death: £1,000,000

Gross value at date of death: £1,000,000

Less nil-rate band: (£325,000)

Less nil-rate band: (£325,000)

Taxable value: £675,000

Less 60% mortgage: (c.£480,000)

Taxable value: £195,000

IHT @ 40%: c. £270,000

IHT@ 40%: c. £78,000

Remittance basis of taxation

Buyers will also need to consider their UK tax status before importing funds into the UK for a property purchase. A remittance basis user who has to remit funds to the UK for a purchase may incur a tax charge if they do not have sufficient clean capital to bring in. In those circumstances, reducing the amount that needs to be remitted by taking out a loan would be a clear advantage (although the remittance basis user would require sufficient clean capital to service the interest on any mortgage).

Tax reliefs

While tax relief on buy-to-let properties has now been curtailed, there are still some advantages for landlords. Landlords can now claim a tax credit at 20% of the interest costs payable under their loan to set against the income tax due on the rent. A loan will make no difference to a buyer’s liability for Stamp Duty Land Tax (“SDLT”) on acquisition or Capital Gains Tax (“CGT”) on the disposal of the property.

Potential disadvantages

The most obvious potential disadvantage for an owner who is borrowing money when they do not really need to borrow it is that they will have to pay interest on the loan. As for all buyers, this may not be seen as a particular disadvantage when interest rates are low, but rates have risen considerably and it is not possible to predict how they will move in the future. Most loans have an initial fixed period at an advantageous rate but then, potentially, revert to a higher rate when that fixed period ends. There may also be penalties for redeeming a loan in an initial period.

The other main disadvantage is the potential increase in cost and delay at the time of purchase. The lender is likely to require a formal valuation of the property which it will expect the borrower to pay for and may wish to be separately legally represented.

Depending on the lender, legal fees might increase significantly particularly where a Sharia complaint mortgage is being used. There is typically a considerable delay in getting formal mortgage offers even sometimes after they have been agreed in principle, but this can vary considerably between lenders. It is worth checking at an early stage if the lender will want to use separate solicitors because this can also add considerably to delay. Sellers are generally aware of the delays and uncertainty that can be caused where a buyer requires finance and often they will prefer to accept an offer from a buyer who offers cash rather than requires finance.

A further point that should not ignored is that the lender may exert a level of control over the property during the period of a mortgage. If the buyer has taken out an owner-occupier mortgage then they will need to get the bank’s consent to then let the property; to do so without their consent is likely to be a breach of the loan conditions. Likewise, some products are specifically only for commercial letting arrangements and for the borrower to occupy the property will be not just a breach of the loan agreement but may breach the lender’s own lending licence. Borrowers are also under obligations to the lender to maintain the property, insure it, and to comply with any restrictions and with the lease terms if it is leasehold.

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