Repayment or Interest-Only Buy-to-Let Mortgage?
As a buy-to-let landlord, you find yourself facing difficult decisions on a regular basis. Whether considering your first buy-to-let investment or managing an extensive portfolio of properties, turning habitable homes into a profit-making business is not easy.
Along with selecting suitable properties in the first place, it is also important to consider the various types of mortgages available. Interest rates and overall borrowing costs can vary significantly from one loan to the next, which could add up to a difference of thousands of pounds over the lifespan of the loan. Comparing the market is essential but you also need to consider the structure of the mortgage itself.
Choosing between repayment and interest-only buy-to-let mortgage deals can be a daunting prospect. If you have any questions or concerns regarding the different types of mortgages available, we are standing by to take your call.
How Are Interest-Only and Repayment Buy-to-Let Mortgages Different?
Most landlords, particularly those who own and manage multiple properties, choose interest-only buy-to-let mortgages over repayment mortgages. It may not be the most appropriate option for aspiring landlords considering first-time property investments but can nonetheless make sense for more established buy to let owners.
With an interest-only mortgage, the initial monthly repayments are significantly lower as you are simply covering the costs of the interest. When the term comes to an end, the rest of the mortgage must be paid back. Standard repayment mortgages differ in that a fixed or variable payment is made on a month to month basis until the entire balance is repaid. Repayment mortgages therefore cost more on a monthly basis during the early stages of the loan.
For standard residential property purchases, interest-only mortgages are considered somewhat risky. Things are nonetheless different where buy-to-let investments are concerned, for which interest-only mortgages can be advantageous in several ways.
Advantages of Interest-Only Mortgages for Buy-to-Let Investors
Recent data from the National Landlords Association suggests that interest-only mortgages remain the most popular choice for buy-to-let investors. This is primarily because the monthly rental income on the property purchased is more than enough to cover the initial interest payments on the properties, which are purchased by landlords as long-term investments.
With the intention to sell the property at a later date and benefit from increasing house prices, the investor is able to make a significant profit while repaying the outstanding balance in full. All while capitalising on the tax efficiency (if the property is held in a limited company) and flexibility of interest-only mortgages, ultimately resulting in significant savings to maximise revenues and profits.
*By April 2020 tax relief will no longer be available on privately owned interest only mortgages.
Tax Advantages of an Interest-Only Mortgage (Held in a Limited Company)
In a working example, a landlord could let out a property for £1,000 per month while paying a monthly interest-only mortgage repayment of £600. This would leave £400 to be taxed on a monthly basis. If the same property had been purchased using a repayment mortgage, the monthly repayment would be approximately £900, though with the same tax-deductible £600. This is all before taking additional expenses and overheads into account.
It is also worth bearing in mind that as you gradually pay off a repayment mortgage and the tax-deductible part of the loan decreases, the tax you pay increases accordingly. Many landlords therefore prefer to save money in the early days with an interest-only mortgage and invest the additional funds elsewhere, using tax-free ISAs or other investments to protect or increase their wealth.
The Disadvantages of Interest-Only Buy-to-Let Mortgages
Interest-only mortgages are not without their disadvantages and potential risks. The most prevalent of which is the possibility that the price of the property may fall, which would mean that its market value when sold may not be enough to cover the outstanding debts.
It may also be inadvisable for first-time property investors to opt for an interest-only mortgage, unless they have a guaranteed strategy in place for repaying the loan balance when the interest has been paid off. A new mortgage can be taken out to cover the remaining balance, or it can be repaid outright if preferred.
Interest-only buy-to-let mortgages are now generally considered most suitable for established and ambitious investors and limited companies focused on long-term gains. There are instances where interest-only buy-to-let mortgages are perfectly suitable for newcomers to property investments, though in all instances should be carefully considered and approached under advisement. If you have any questions regarding the pros and cons of interest-only mortgages or would like to discuss your buy-to-let business ideas in more detail, contact a member of the team at UK Property Finance anytime.