Rent a room scheme: what is it and how does it work?

With mortgage payments soaring, many households need to find a little extra cash to meet their monthly outgoings.

If you’re a homeowner, you could take advantage of the government's rent a room scheme and quickly earn some tax-free cash.

Here’s the breakdown of what the rent a room scheme is.

Why are mortgage payments rising? 

With inflation rising, the Bank of England has been raising interest rates to try and bring prices down.

But with interest rising, so too are many people’s mortgage payments. Especially for those on variable and tracker mortgages.  

High interest rates mean that the cost of lending money is higher, so lenders, such as banks, are more reluctant to lend money, and need a more attractive deal to encourage them to do so.

As a result, interest rates tend to increase, making it harder for households to keep up with their monthly payments.  

What is the rent a room scheme?  

With mortgage payments increasing and households needing to find a little more cash at the end of every month, many people need a way of earning a little extra. Renting out a room is one way you could do this.  

The rent a room scheme is a government relief scheme that lets people rent out a room in their house, with the first £7,500 of rent payments coming free of tax.

If the rental income is being shared between two people, only the first £3,750 per person is tax-free.  

How does the rent a room scheme work? 

Whether you own your home, or just rent, you could choose to rent out a room in your house so as to earn £7,500 worth of tax-free income.

This tax exemption applies automatically, so if you earn less than this, you don’t need to do anything.

If you earn more, however, you need to complete a self-assessment tax return to declare your earnings.

It is also possible to opt out of this particular scheme and pay your taxes on your rental income differently.  

Who is eligible to take part in the rent a room scheme? 

You don’t have to be a homeowner to take part in the scheme.

Whether you own a property, or are a tenant, you can take part in this scheme if the room being rented out is fully furnished.

If you are a tenant, you need permission from your landlord. For landlords, it’s important to have permission from the property’s insurer.  

What are the tax benefits of the rent a room scheme? 

The first £7,500 of your income under the rent a room scheme is tax-free.

If you earn more than this, you need to fill out a tax return and to pay any outstanding tax. However, when filling out your self-assessment, you have the choice on how to pay your tax.  

There are two ways to tax property income. The first is to pay tax on your income in the same way as a rental business by paying tax on your actual profit after deducting expenses.

Or, you can choose to take £7,500 tax-free, before paying taxes on excess rent beyond this.  

In practice, this means that if you choose the first option, you only pay tax on any profits you have made and after you have claimed any expenses back.

With this option, you don’t keep your £7,500 tax allowance. With the first option, you keep any annual rent that falls within this £7,500 allowance, with any additional income being charged at your top rate of tax.  

When it comes to choosing how you pay taxes on your rental income, you need to do the calculations to figure out which option is right for you.

There’s no obligation to stay in the rent a room scheme, so if you find that it is better for you to pay your tax a different way, you can change easily and quickly.  

Does rent a room apply to Airbnb properties? 

The rent a room scheme covers short-term rentals, and includes any rentals offered through Airbnb.

For people renting properties through Airbnb, an alternative tax allowance is on offer.

You can claim a tax allowance of up to £1,000 each tax year if you are renting through Airbnb, but this allowance can’t be used at the same time as the rent a room scheme, so may not be the right option for you.  

How does the rent a room scheme affect your benefits? 

If you are receiving Housing Benefit, rent a room affects your benefits differently depending on the status of the person renting your room.

If you are providing a room and food, your renter is classed as a boarder. The first £20 of rental income a week is disregarded along with half of the remaining rent you receive.  

If you are providing a room only, your renter is classified as a sub-tenant. In this case, the first £20 is disregarded, and the rest is seen as income which you keep.  

If you are receiving universal credit, your rent a room scheme income isn’t classed as income and doesn’t impact your universal credit payments.  

The rising cost of living is a challenge for everyone, but there are ways for you to keep ahead of rising costs.

Speak to a financial adviser today and start protecting your savings today. Find an adviser on Unbiased.