Rent A Room scheme: tax-free cash from your spare room
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You can earn thousands of pounds a year tax-free from your spare room
Thanks to the Government’s Rent a Room scheme, you can currently earn up to £4,250 in rental income per year without paying a single penny in tax. If you rent out a room jointly (perhaps as a couple) you can each earn up to £2,125 tax-free.
Better still, you won’t have to declare this income if you don’t normally complete a tax return, and there's no need to apply for the scheme either. The exemption is automatic. What could be easier?
That means you could earn over £350 a month from your spare room totally tax-free! You don’t even need to be a homeowner to benefit from the scheme. If you’re a tenant yourself – and your landlord agrees – you can rent out a room too.
Even better, from 6th April 2016, this tax-free threshold will rise to £7,500, meaning that housing a lodger paying up to £144.23 a week – around £625 per month – won't cost you anything in tax.
What's more, one lender has now designed a special mortgage to help first-time buyers take advantage of the scheme!
Rules of the scheme
There are some rules to the Rent a Room scheme to bear in mind before you let and during your lodger's residence:
- The room you let has to be furnished and it has to be a room in your main residence.
- The lodger can occupy a single room or an entire floor, but it must be part of your home and cooking and bathroom facilities should be shared.
- You must carry out annual gas safety checks on your boiler, and provide smoke alarms and fire-resistant furniture. Visit the Gov.uk website for more details.
- You can’t claim for expenses such as heating, lighting, wear and tear, repairs or insurance.
- If you're going to charge for other services, such as meals or laundry, you'll need to add this amount to the rent to work out the total.
- If you live alone and claim the single person's Council Tax discount, you will lose this if you take in a lodger, unless they are exempt from paying Council Tax.
If your rental income is above £4,250 in a year, you must complete a tax return and pay Income Tax on anything you earn over the tax-free threshold.
Depending on how much it has cost you to rent the room out, you need to decide whether you want to pay tax just on the profit you've made above the £4,250 threshold via the Rent a Room scheme.
Alternatively you can pay tax on the profit you've made minus any expenses, which means opting out of the Rent a Room scheme and treating the money as taxable rental income.
You can change which method you use each year but you must tell the taxman in advance. There's more information on this and some examples on this section of the Gov.uk website.
Who could you rent your room out to?
Demand from tenants is strong, as would-be first-time buyers are increasingly being forced into delaying property purchases. These days, lodgers are often professionals who want a decent place to live, but simply can’t afford to buy themselves.
Foreign language students often prefer to lodge with a family rather than rent – they get the benefit of family life when far from home, and the family can benefit from a housemate from a different culture. And an added bonus might be that you all start to learn your lodger's language, too!
You could boost your income temporarily by taking on seasonal lodgers if you live somewhere likely to attract visitors. For example, residents in Edinburgh often rent out rooms during the festival.
If you don’t fancy sharing your home all the time, think about letting out a room Monday to Friday. This can be useful for workers in your area who want to avoid a long commute home. As a general rule, 60% of the normal weekly rent is usually appropriate for a weekday lodger.
Where to advertise for a lodger
Good websites to check out include the free classifieds site Loot, Easyroommate, Gumtree, and MondaytoFriday (this is a great website if you don't want your lodger around at weekends) or you could try placing a free ad at Spareroom.
It may also be worth placing notices in local shops, hospitals, large employers and universities/colleges (if you're looking for staff or foreign language students).
Top tips for finding a good lodger
Follow these tips to avoid letting your spare room to the wrong person:
- Interview prospective tenants. Find out how much time they'll spend in the house, how they spend their evenings and weekends and what they do for a living. Make sure you cover the house rules.
- Carry out a tenant check before you agree to take someone into your home. You could try the National Landlords Association. Don’t forget there will be a fee.
- Ask your prospective lodger to provide references from their bank or building society and their employer or previous landlord. You could even ask for a character reference.
- Write up a formal agreement between you and your new lodger. Include the following details:
- The amount of rent including any share of the household bills
- When and how the rent is to be paid
- When the rent will be reviewed
- The notice period
- Which rooms or facilities your lodger is entitled to use.
- Any house rules which you feel are relevant.
- Ask for a deposit of at least month's rent upfront. You can use this to cover the cost of any unpaid rent or damage to your home.
- Keep a careful record of the rents you receive and any expenses you incur. You must retain these for six years following the tax year end.
You can get plenty more tips and advice from the National Landlords Association.
Check your mortgage's terms and conditions
Most lenders should be fine with you taking in a lodger, but you should contact them and tell them what you're planning to do before you advertise your room for rent.
First-time buyers looking at a property with a spare bedroom can get some help securing a mortgage. Bath Building Society has launched a Rent a Room Mortgage that will let them use income from letting out a spare room to help towards their mortgage repayments.
So how does it work? Let's take an example. Say you have an applicant who earns £26,000 a year and wants to buy a two-bedroom house for £200,000. They have a 20% deposit so will need a £160,000 loan. The mortgage providers that they've seen don't want to lend that amount of money based on a £26,000 income. The applicant has a friend who needs a place to live and is happy to pay £400 a month to rent the spare room. With a Rent a Room Mortgage the rent would cover about £58,500 of the loan, leaving £101,500 to be covered by income.
There are a few caveats though. No more than 50% of the loan can be covered by rental income, and the sum being covered by the rent must not be more than four times the borrower's income. Rental income from only one tenant will be taken into account.
The maximum loan to value is up to 85% and the applicant must earn a minimum of £20,000 a year.
A written agreement between the borrower and the tenant will need to be shown to the building society and renewed on a regular basis.
However, if the tenancy goes a bit pear-shaped it needn't have a devastating impact. The agreement between the borrower and the tenant doesn't need to be in place for the whole loan, as there may come a time when the borrower can make the remaining repayments themselves.
It can be hard to predict what will happen between the two of you in future, but it's important that you consider how your relationship with the tenant and their circumstances will change over the course of the loan before you go ahead.
Check your insurance
Another important point to note if you decide to take in a lodger is that you'll need to carefully review your home insurance policy.
For a start, you must make sure you tell your insurer if you are planning to rent out a room. If you fail to do so, any cover you already have in place could end up being declared void. Be warned though that you may have to pay a higher premium on your home insurance for taking in a lodger.
Some insurers will also only cover you for one lodger, while others will cover you for more. It's also worth keeping in mind that some insurers won't cover students as they are classed as high risk.
However, even if you're covered, be aware that the level of cover you have could be impacted by taking in a lodger. For example, claims for accidental damage, attempted theft, vandalism or malicious acts may not be covered.
Theft cover may only be included if there has been evidence of forcible entry. So make sure you check the terms and conditions of your policy carefully.
It's also very likely that your tenant will need to get their own contents insurance policy as your tenant's contents probably won't be covered under your main policy. Unfortunately, standard home contents policies generally won't cover a bedroom in a property because it has to have its own locked door.
Your tenant would need to apply to an insurer that specialises in renters to see whether they could get cover. Endsleigh is one of the few insurers to offer shared house contents insurance.
The next big question is what happens to your home insurance policy if your tenant has an unspent criminal conviction? Unspent convictions can invalidate your policy.
This can have serious consequences. If, for example, your home burns down and your tenant had an unspent conviction, even if it's conviction for something as minor as overpayment of benefit, your buildings insurer could refuse to pay out.
So if you're taking in a lodger, you need to be able to prove you took reasonable steps to find out whether your tenant has an unspent criminal conviction.
You should also be able show you performed reasonable checks on your lodger's background and history (such as performing a credit check, and asking for references from your tenant's employer and bank), as your insurer may ask for proof of this later.
It would also be wise to get your tenant to sign a declaration that he or she has no unspent criminal convictions, and get this witnessed. Make sure you put a date on this document.
The good news, however, is that if you take these steps and later you find that the tenant has lied to you, then the policy is likely to remain valid. In other words, if you've taken reasonable steps to find out about any unspent criminal convictions, then you should be OK and a payout should be made.
If it is not and you have exhausted all paths to refute the rejection of your claim, you can go to the Financial Ombudsman Service for redress.
Don't rely on the income always being there
If you like the idea of sharing your home for extra cash, then go for it. But be careful not to rely on it too heavily. After all, lodgers can leave at short notice and you don’t want to be left short of money.