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The tax deduction for interest on home loans has effectively disappeared. For many people who own their own home or use it for private housing, this restriction is a significant financial factor. This change can significantly reduce your taxable income if you own more than one home, are starting out in property investment or are a landlord.
When the purpose of the loan is changed to an income-generating loan, all interest expenses on the loan become fully tax deductible. This change allows for a full tax benefit, which reduces taxable income and significantly improves cash flow. Such a solution is particularly important for housing investors and landlords as it helps to optimise financing costs and increase the return on investment.
In this guide, we go through essential background information and basic concepts, such as the differences between a mortgage and an income-generating loan, the key elements of loan terms and financing (repayment period, instalments, Euribor rate, margin and collateral) and tax aspects. The guide also explains why the correct disclosure of the purpose of the loan on the tax return is crucial for achieving the full tax benefit.
Traditional mortgages have often been taken out for owner-occupation, thus eliminating their tax deductibility altogether. This means that interest costs on owner-occupied loans are no longer tax deductible, which limits the tax benefits and can reduce overall cash flow. In contrast, an income-generating loan is designed to generate taxable income - for example, renting an investment property - in which case all interest costs on the loan are tax deductible, allowing for full tax benefits. Therefore, declaring the correct purpose on the tax return is crucial to ensure that the full benefit of the interest on the loan is received for tax purposes.
The terms of the loan include, among other things:
For tax purposes, the decisive factor is the purpose for which the loan is used:
Recent tax updates have a direct impact on the tax benefits of converting a mortgage into an income-generating loan. In particular, these changes highlight the fact that the deductibility of interest on loans used for owner-occupied housing has been eliminated, and in order to receive the full tax benefit, the loan must be converted into an income-producing loan.
The interest deduction on loans for owner-occupied dwellings has been completely abolished from the beginning of 2023. This means that interest expenses on owner-occupied home loans will no longer be tax deductible. If the loan remains a conventional mortgage, the tax benefit will be very limited, which will significantly reduce cash flow. Changing the purpose of the loan to an income generating loan ensures that all interest costs are deductible.
In the case of income-generating loans used to finance investment housing, all interest expenses are tax deductible. This means that the total cost of the loan is reduced for tax purposes when the loan is properly declared as an income loan on the tax return. Full deductibility offers a significant advantage over allowing deductions for only part of the interest costs.
Nowadays, the deadlines for tax returns have been brought forward and pre-completed tax returns are arriving earlier than before. This allows for faster detection and correction of incorrect information, such as misreporting of the purpose of the loan. Ensuring correct information is crucial to ensure that tax deductions are fully realised.
Under the new rules, the maximum amount of the household allowance has been lowered to €1,600 per person and the deductible has been raised to €150. These changes will have a particular impact on situations where you carry out renovations or other household services to support your rental business. The change in limits highlights the importance of allocating costs correctly to maximise the tax advantage in generating income.
The tax exemption for first-time buyers will be abolished between 2024 and 2025. This development makes it clear that the purpose of the loan must be clearly defined in order to obtain tax benefits. If the loan is converted into an income-generating loan, the interest deductibility of the loan will remain full - which is particularly important when first-time homebuyers' benefits no longer provide additional benefits.
The above tax changes have a direct impact on how a change in the purpose of a loan can bring full tax benefits, improve the profitability of the investment and strengthen cash flow. Properly implemented, the change will allow for a reduction in all interest costs on the loan, making it an attractive solution for home investors and landlords.
Let's imagine a situation where a homeowner who has been living in his own home decides to convert it into a rental investment property. In this case, the purpose of the loan must be changed to an income-generating loan so that all interest expenses on the loan are tax deductible.
Loan details:
Tax deduction before the change:
Since the deduction for interest on a loan used for your own home has been abolished, you will not receive a tax benefit on the interest on the loan.
The details of the loan remain the same, but the purpose is changed to an income-generating loan.
This example illustrates how the situation changes dramatically when the purpose of a loan is changed to an income-generating loan. This change has a full tax benefit as all interest expenses are deducted, improving the financial profitability and cash flow of the investment.
To understand the total cost of a mortgage, it is important to familiarise yourself with the technical details of the loan terms. In this section, we will go through the key terms that affect the price and instalments of the loan.
The loan margin is the bank's own mark-up added to the loan's reference rate. It is customer-specific and influenced by a number of factors, including:
For example, if the reference rate is 1.5% and the bank charges a margin of 0.6%, the real interest rate on a loan is 2.1%. Bank margins can vary significantly, so it is important to compete.
The reference rate is the base rate set by the market, to which the bank adds its margin. In Finland, the commonly used reference rate is the 12-month Euribor, but shorter options such as 3-month and 6-month Euribor are also available.
The choice of the length of the reference rate depends on the borrower's risk tolerance and the importance of predictability compared to the potential savings.
Interest rate hedging aims to ensure that the interest cost of a loan remains under control, even if market interest rates rise. The main forms of interest rate hedging are:
The cost of interest rate hedging is often added to the margin of the loan and therefore affects the annual percentage rate of the loan. It is therefore important to assess when it makes economic sense to use interest rate hedging.
The Annual Percentage Rate (APR) of a loan consists of the reference rate, the margin and other loan-related charges such as origination fees and loan servicing fees. The APR gives a comprehensive picture of the cost of the loan and is the best point of comparison between different loan offers.
For example, if the loan is tied to a 12-month Euribor rate of 1.5% and the bank's margin is 0.6%, the nominal interest rate on the loan is 2.1%. Additional charges, such as opening and account management fees, increase this percentage slightly, and the final annual percentage rate could be, for example, 2.3-2.5%.
By understanding the impact of the loan margin, reference rates and interest rate hedging, you can better assess which loan offer is most advantageous for you. It is advisable to compare offers from several banks and negotiate favourable terms to keep the overall cost as low as possible.
In summary, the conversion of a mortgage loan into an income-generating loan offers significant tax advantages when the loan is used for investment or rental purposes. The conversion makes all interest expenses on the loan tax deductible, which improves the economic viability of the investment and enhances cash flow. In addition, reporting the correct use on the tax return will ensure that the tax benefits are fully realised.
Now is the time to take action! First, review your situation, talk to your bank and make sure all the steps are in place - so you can take full advantage of the benefits of turning your mortgage into an income-generating loan.
