Comparing Gifted Equity deposit vs Director’s Loan to fund your Limited Company Buy-to-Let Mortgage
Gifted Equity deposit vs Director’s Loan: What is the difference? When moving a buy-to-let investment property from personal ownership to a limited company, one of the critical decisions you will face is how to fund the deposit for the purchase.
Two common methods are using a “gifted equity” limited company mortgage or a “director’s loan.” Each approach has its own benefits and considerations. This article will explore the differences between these two funding strategies, helping property investors make informed decisions about buy-to-let mortgages.
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Herein I discuss buy-to-let mortgages within an SPV limited company that was formed with the specific purpose of buying and holding property, which has been reflected in its Standard Industrial Classification (SIC codes) when registering the company, with the donor of the “gifted equity” or a “director’s loan” being the sole owner of the SPV. More elaborate schemes, such as holding companies and multiple owners, have been left unrefined for another time. If you would like guidance on the acceptable SIC codes of buy-to-let mortgage lenders, please drop me a line using our Contact Us form on this website.
I must stress, though, that I’m a Mortgage Broker, and I’m looking at the subject from a mortgage perspective. In all instances you should seek suitable tax advice from a professional Tax Specialist.
What is a Gifted Equity Limited Company Buy-to-let Mortgage?
A gifted equity limited company buy-to-let mortgage involves transferring equity from a property you own into your limited company as a gift. This equity forms part or all of the deposit required for the mortgage. Here’s how it works:
- Equity Transfer: The property’s equity is transferred from your ownership to the limited company.
- Mortgage Application: The limited company then applies for a mortgage using the gifted equity as the deposit. A gifted equity letter will need to be provided. We can provide a template on request.
- Completing the Transfer: Once the mortgage is approved, the property is officially transferred into the limited company’s name.
Example
Jason bought a buy-to-let property in 2002 and has let it out since. He has seen the benefits a SPV limited company for property provides so he wants to transfer his property into a Company he has set up of which he is the sole director.
As the SPV limited company has been recently formed, and is called Top Property Limited, it has no regular income or savings. From his research he has discovered that to finance the purchase he will need at least a 20% deposit (and more likely 25%), for the buy-to-let mortgage lenders to be willing to lend. The Company does not have the means to pay for the deposit.
The daft thing is it’s really his asset, i.e. it’s currently owned personally in his name, and the SPV limited company is his too. In fairness, most of the buy-to-let mortgage lenders recognise this, although not all of them do. Those that do will allow is a “gift of the equity” from Jason to Top Property Limited (effectively himself!).
Property value and purchase price £200,000.
Buy-to-let limited company mortgage £160,000.
Deposit required £40,000, a 100% gift by Jason to Top Property Limited.
Top Property Limited will be the owners of the asset and receive the rental income.
As part of the process, Jason has personally completed a “gifted equity” letter waiving his rights to the property and also confirming he has sought independent legal advice.
Advantages of a Gifted Equity Buy-to-let Limited Company Mortgage
- No Additional Cash Needed: The Buy-to-let Lenders that allow “gifted equity” can accept this as the sole source of deposit. The SPV Buy-to-let limited company does not have to contribute anything.
- Tax Efficiency: This method can be tax-efficient as it may reduce personal tax liabilities.
- Simplified Process: The deposit is “equity” so the money laundering audit process should be straightforward and there is no property chain to consider.
Considerations of a Gifted Equity Limited Company Mortgage
- Valuation and Lender Requirements: Not all lenders accept gifted equity, and those that do may have specific valuation and documentation requirements. The purchase price will generally need to be reflective of the open market value and cannot be inflated as the Buy-to-let Lender’s own valuation will set the mortgage amount. The extra documentation will include the “gifted equity” letter.
- Stamp Duty: It’s important to understand this is a “purchase” transaction” and not a “remortgage”, so transferring the property may trigger stamp duty and other transfer costs.
- Equity Release: The amount of equity that can be gifted is limited to the current value of the property minus any existing mortgages.
What is a Director’s Loan?
A director’s loan involves lending money from the director (you) to your SPV buy-to-let limited company. This loan can then be used to fund the deposit and purchase of the buy-to-let property. Here’s how it works:
- Loan Agreement: You lend money to the SPV buy-to-let limited company, typically documented through a formal loan agreement.
- Funding the Deposit: The SPV buy-to-let limited company uses the loan funds to pay the deposit for the buy-to-let mortgage.
- Mortgage Application: The limited company applies for a mortgage using the director’s loan as part of its funding.
Example
She has formed an SPV called Red Real Estate Limited, of which she is the sole director. She plans to lend her personal savings to the Company as a director’s loan to help fund the deposit. From an Accounting perspective, this loan is recorded in the Director’s Loan Account.
Red Real Estate Limited applies for a Limited Company Buy-to-let mortgage for the remainder of the money needed.
Property value and purchase price £200,000.
Buy-to-let limited company mortgage £150,000.
The director’s loan of £50,000 was provided by Ling Maye from her bonus.
Red Real Estate Limited will be the owners of the asset and receive the rental income. They will also the rents to repay Ling Maye director’s loan.
Advantages of a Director’s Loan
- Flexibility: Director’s loans offer flexibility in terms of repayment and interest rates.
- Control Over Funds: You maintain control over the funds, which can be beneficial for future planning.
- Potential Tax Benefits: Depending on your circumstances, there may be tax advantages to lending money to your company.
Considerations of a Director’s Loan
- It limits Buy-to-let Mortgage Lender Choice: There are still a good number of active buy-to-let lenders in this market but they are more likely to be the specialist lenders that securitise their funds rather the more keenly priced mainstream buy-to-let providers that have access to deposits for their funding.
Loan Repayment: The SPV buy-to-let limited company will need to repay the loan, which could impact cash flow. - Interest Rates: If interest is charged on the loan, it must be reasonable and reflect a commercial rate.
- Documentation: Proper documentation is essential to ensure the loan is legally binding and compliant with HMRC regulations.
After the loan is repaid, Any further income taken will be subject to usual taxes.
Key Differences Between Gifted Equity and Director’s Loan
Ownership and Control
- Gifted Equity: The equity is transferred to the SPV buy-to-let limited company and all ownership ties are relinquished.
- Director’s Loan: The funds remain a loan, and you retain a creditor relationship with your SPV buy-to-let limited company.
Financial Implications
- Gifted Equity: This may involve stamp duty and valuation costs but does not require additional cash.
- Director’s Loan: Requires liquid funds to lend to the company but offers repayment flexibility and potential tax benefits.
General Tax Considerations
- Gifted Equity Can be tax-efficient but, depending on the property’s value, may involve capital gains tax implications.
- Director’s Loan: Potential tax benefits on interest payments, but interest must be at a commercial rate to avoid tax issues.
Conclusion
Choosing between a “gifted equity” deposit or a “director’s loan” to fund your limited company buy-to-let mortgage depends on your financial situation, tax considerations, and long-term investment strategy.
You should think carefully about your approach and discuss it with your professional Tax Adviser. You should also contact a specialist Mortgage Broker, such as Niche Advice, to ascertain the potential differences in mortgage product terms between the two approaches.
For more insights and expert advice on property investment and financing, follow our articles and YouTube channel, and stay updated with the latest trends and tips in the world of buy-to-lets.
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