Today has been budget day here in the UK. George Osborne, Ozy for short, has produced his first true blue budget and most early comments is along the lines: 'it's not as bad as it might of been'. It did, however, manage to nudge the Greeks of the head of the news but not much of interest happening there until their PM presents their proposals for a new bail-out package tomorrow. But what caught my eye in the budget was the removal of the tax shield attaching to 'buy-to-let' mortgages first for high rate taxpayers from 2017 onwards and, ultimately, I am sure for standard rate tax-payers. There are two important issues here: the first is whether this presages the removal of the tax shield on all business loans for the unincorporated self-employed and second, what the unintended consequences might be. My interest here is the 2nd point, and this is my reading of what will happen. My observations are based upon the fact that Buy2Let mortgages are significantly more expensive than their equivalent in the personal property market.
I have long suspected that mortgage companies, like trades people working for land-lords. try to 'bump the price'. They are aware that any expense is tax deductible and trade on the basis that at the margin the land-lord is prepared to pay correspondingly more. So this is my guess: as the tax shield comes off, mortgage companies will be under pressure bring their rates down as the distinction between the Buy2Let and conventional mortgage disappears. As a result their margins and their regulatory capital will be squeezed restricting the additional loans they can make. Make no mistake the tax shield is not much benefit to the land-lord but has, in my view, been a a back-door subsidy to the mortgage companies who have leapt at this rather tasty corner of the mortgage market.
If the market corrects fully I suspect the effect will be broadly neutral and this is the line of argument that M&M made in rebutting the so called tax-shield effect on the WACC. OK, the tax shield is a benefit to the borrower - only if the lender lets them have it. But in a world where lenders have the market power it's significance on the cost of capital is moot to say the least.