How to go about obtaining the necessary funds to purchase a property from an auction all depends on what you intend to do with it once you’ve bought it. For example, if you intend to sell the property quickly for profit, you would be unwise to tangle yourself up in, say, a five-year fixedrate mortgage with penalties for early redemption.
You have to consider which is the best financial instrument to use given the plans you have in mind and your individual circumstances.
For now I want to consider cash.
Is Cash King?
Now, let’s take some cash to an auction. This sounds like the best way to buy a property from auction, doesn’t it? The person lucky enough to have tens of thousands of pounds stuffed in a bank account has an advantage over those who have to arrange mortgages, don’t they? Well, yes and no. Yes, they don’t have to ask anyone’s permission to go ahead with a deal; there’s no obligation to cross-refer with a lender, so they are that much more in control of the whole process. Further, for someone who has cash, buying at auction can be a cheaper proposition than for someone who is obliged to pay for a valuation (for mortgage purposes), a lender’s arrangement fee and interest on a loan. Cash can speed the whole process up, too. Rather than just paying the obligatory 10% on the fall of the hammer, a cash buyer can pay the whole shooting match in one fail swoop. Bang, hammer down, “sold to the gentleman with the moustache, oh, sorry madam,” cash on the table, and if your solicitor is present, the transfer of ownership can be executed maybe in hours, certainly days, rather than the few weeks it would take for mortgage monies to come through. Cash can also secure a bargain before an auction.
Often you’ll see in a catalogue, or read printed on a faxed guide price sheet, or hear spoken by the auctioneer prior to the commencement of proceedings the words “Sold Prior.” This means that someone has made an offer for the property that has been accepted by the vendor in advance of the sale taking place. Good deals can be snapped up by doing this. Vendors are often only too pleased to be made advance offers, at around the guide price level, as they may receive their funds up to 8 weeks ahead of sale at auction to a buyer with a mortgage to arrange (4 weeks after the sale to completion, plus 4 week prior to the sale when the catalogue comes out). The vendor can never be sure that the property is going to sell at the auction anyway. If the offer is at all reasonable the vendor may be happy to accept this rather than gamble on the vagaries of an auction situation, particularly if the buyer makes it plain that the offer will be withdrawn once the auction commences. If you brazen enough, the cash buyer can even make silly bids prior to the auction. The worst that can happen is that you’ll receive a rejection, but you could just get lucky. It all depends on how desperately the vendor needs to liquidate the property and you’re not going to know that unless you attempt a purchase. Allin-all, cash buyers do have the advantage that they can steal bargains away from competitors and pick up properties before they ever come under the hammer.
However, having said all that, some vendors are determined that their properties are going to be sold by auction. For example, councils have to be seen to be being open, fair and honest so as to avoid potential accusations of sleaze. An auction arena is as overt as it gets. Whoever buys the property, even if it’s the Mayor, can never be accused of any underhandedness. The whole world could bid, the whole world could buy and everyone could see the affair taking place fairly and squarely. An accepted offer prior to auction may set alarm bells ringing and investigative journalists might smell a rat. Even if a rat doesn’t exist, you know what some journalists are like – never letting the truth get in the way of a good story. Other vendors also want to push for an auction sale for similar reasons. Sales of repossessions have to be overt, to cover the backs of the “mortgagees in possession.” The Ministry of Defence, the Home Office, the Department of Education and all other government departments and agencies have to behave similarly to councils when disposing of surplus land and property assets. There are many reasons why sale by auction is the most appropriate method of disposal of many properties, despite the fact that returns are unlikely to be as high as via a private treaty sale, but the most important of all is the openness of the market forum, its transparency.
And if a property has to be sold at auction, apart from being able to complete in a hurry, the cash buyer has no great advantage over anyone else in the auction arena.
Do You Really Want To Use Cash?
But anyway, even if you do have the means at your disposal, do you really want to pay for your property with cash? There are huge tax disadvantages by doing so, particularly if you’re considering buying to let.
As discussed elsewhere, buying to let should be considered a medium to long-term investment. We’re looking for our tenants, or series of tenants, to pay off our mortgage for us in 10 to 25 years. Therefore, having our property highly geared – ie lending as much money as we can and putting up as small a deposit as we can get away with – is advantageous. The less of your own money you have to put down the more you will have available, perhaps to put down on another property, and another, and so on. Remember that the interest you pay on the mortgage can be set against the amount of rental income you receive from the property for income tax assessment purposes, together with other costs (to be discussed at some other time). You will only pay tax at your marginal rate, on any balance in your favour, if there is a balance at all. Which is great! The government effectively subsidises your investment.
Simplistically speaking, if the mortgage interest payments are £5,000 pa and the rental income is £5,000 pa then no tax is due. If the Treasury (bless ‘em) did not allow you to do all this ‘setting against’, standard rate taxpayers would have to stump up £1,150 pa and higher rate taxpayers a whopping £2,000 pa, which might well make buying and letting unviable. (I bet if they changed that legislation property prices would come tumbling down even more quickly.) But … and it’s a big ‘but’. BUT … the taxman will not allow you to set interest against income if you take out a mortgage on a property that you already own. If you pay cash for a property and then decide to let it out and want to mortgage up to the hilt and have the tenant pay the loan off then you can do so, of course, but you will have to pay tax on the income. You will still be able to set against the income repairs and insurance costs and the like, but not interest payments. You cannot even increase an existing mortgage to set more interest against income. You can remortgage, with the same lender or change lenders, but if the new loan is for a higher amount than the original, you will only be allowed to set against the proportion of the interest which represents the original mortgage. I don’t know why this is; I’m just informing you that it is, as I have found out to my cost.
One of the properties that I rent out is in London. Whilst I was living there, whenever windfalls came in or whenever I was able to put savings away I occasionally paid off lumps of the mortgage. It seemed the sensible thing to do at the time; I was receiving 4% interest from the bank deposit account (after tax deductions) and paying 8% on my mortgage at the time. By switching funds I thought I was being very clever by effectively doubling the return. But I didn’t look to the future. I didn’t look to a time when I would move out of town and rent the place and mortgage rates would plummet. I now have a relatively small mortgage on that property and receive not an inconsiderable income from it. And I hate the fact that I have to pay tax on most of that income. But I can do very little about it. What’s done is done.
I tell the story so that you don’t make the same mistake. Cash is great when it comes to snapping up bargains from property auctions, but it all depends on what you want to do with the property once you’ve bought it. If you want to renovate and sell then fine, use cash. But if you want to let and take advantage of the marvellous tax concessions available then put as little of your own money down as possible. Cash may be king, but gearing is great!
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Daniel Peacock