An interest-only mortgage can certainly keep your monthly costs down, but there are a number of factors landlords should consider before choosing this option.
Mortgage costs have increased for the vast majority of borrowers over the past couple of years, as a reaction to a range of contributing factors including wider economic and political uncertainty, both globally and within the UK.
For some property investors, this rise in interest rates has had more of an impact since Section 24 tax changes came into full effect in April 2020, which meant mortgage interest payments could no longer be treated as a tax expense deductible from your income tax bill. Instead, landlords get a 20% tax credit on interest payments.
Those looking to reduce their monthly mortgage outgoings may therefore be tempted to take out an interest-only mortgage. Anyone can apply for an interest-only option, but it is particularly common among property investors, who often sell the property at the end of the mortgage term to pay off the capital, having made a profit thanks to value growth.
The difference between an interest-only mortgage and a repayment mortgage
With an interest-only mortgage, you only pay back the interest on your loan. If you’ve borrowed £200,000 over a 20-year term, and you take out a 5.5% mortgage on an interest-only agreement, you’ll be paying back about £917 per month.
By contrast, on a repayment mortgage, your monthly total will be made up partly of the interest on the loan, and partly of a repayment amount to chip away at what you owe; so on the same amount of borrowing, your monthly mortgage bill would be about £1,376 a month.
Based on those figures, it is easy to see why an interest-only mortgage could be tempting, particularly in the current climate of higher interest rates than pre-pandemic. Where landlords are solely looking to reduce their monthly outgoings, this is a straightforward way of achieving it.
The difference is that with a repayment mortgage, by the end of your 20-year term (during which time you will likely have fixed onto a variety of different products and interest rates), you will own the property outright. On an interest-only mortgage, you will still owe the £200,000 you borrowed in the first place.
The exception to this is if you make overpayments on an interest-only mortgage, with most banks allowing you to overpay by up to 10% of your balance per calendar year. These overpayments will be taken off the amount you owe, reducing your loan size.
Pros and cons for landlords
While an interest-only mortgage might be the perfect option for some landlords, it will not be the best idea for others, and this will depend on numerous factors. An independent financial adviser or broker can assess this on a case-by-case basis for investors looking for advice.
One of the main advantages for landlords of an interest-only option is the fact that you keep more of your monthly income. If your main investment goal is to generate an income while you own the property, this can therefore work well, allowing maximum monthly yields.
If you own a property for a long period of time in the UK, it is extremely likely to have gained in value over that time. Therefore, when the time comes to sell, although you will still owe the full amount of borrowing to the bank – plus capital gains tax and other sale costs – most landlords make a lump sum profit at this point, too.
Interest rates are also very similar between interest-only mortgages and repayment ones, so there isn’t normally an incentive in terms of mortgage rates to select one or the other. Having a large deposit – owning more equity in the property – can also ensure you have the widest choice of lenders and products to choose from.
However, one thing to take into account is the fact that, if your interest rate doubles, which has been the case for some remortgaging recently after being on long-term products, so do your monthly payments. By contrast, although you already pay a higher monthly amount on a repayment mortgage, the increase won’t be quite as steep.
Another downside for some landlords, already mentioned, is the fact that you still have borrowing to pay off at the end of your mortgage term.
It is important to note that, in the vast majority of cases, you can switch your mortgage from repayment to interest-only, or from interest-only to repayment. In this way, you can keep your monthly outgoings down when it is needed, but then begin to pay off the mortgage again once you are in a better position to do so.
