Financing a buy-to-let property purchase means choosing between a repayment or interest-only mortgage, and both options have their relative pros and cons for landlords.
The buy-to-let mortgage market in the UK is booming, as lenders compete to offer the best products at the lowest rates, so it’s a good time to secure a mortgage if you’re a landlord.
As well as choosing a lender and a mortgage product that works for you, landlords must decide how they’re going to pay for it, opting for either a repayment or interest-only plan.
What’s the difference?
Repayment mortgages involve paying off part of the capital as well as interest on the loan with each monthly payment. This means that you are slowly chipping away at the amount you owe, which will see it reduced over a period of time. At the end of the mortgage term, you will have paid off everything you owe, and own the property outright.
Interest-only mortgages mean only the interest owed to the lender on the loan amount is paid with each monthly payment – so if you borrowed £80,000, you would still owe £80,000 at the end of the term. At the end of the mortgage term you need to be able to pay off the full loan amount either through selling the property or through some other means.
Interest-only for landlords
Many buy-to-let investors will opt for an interest-only mortgage because it is so much cheaper per month, meaning that monthly profits from rent are much higher. The extra money could be invested elsewhere, or put towards renovations, and this could make you more money in the long run if used wisely.
At the end of the mortgage term, the investment property can be sold to pay off the mortgage, while hopefully benefiting from house price inflation to add to the profit.
If you are not planning to sell the property at the end of the mortgage term, then another way must be found to settle the loan amount. This could be a repayment vehicle such as a savings fund or pension, or another lump sum.
The downside is that it will be more expensive overall because the level of interest you pay will not reduce – the amount you owe remains the same throughout the mortgage term. It also has the potential to be more risky. You are relying on being able to pay off the full amount at the end of the term, so must have a plan in place to make sure this happens. If there is a shortfall when it comes to selling the property, for example, you might not have the funds to pay it off. However, for those who make good investments, the risk should be relatively low.
Considering a repayment mortgage
The main benefits of a repayment mortgage are that you will fully own the property at the end of the term, and you will pay less interest in the long run as the amount you owe is always being decreased. This can be very appealing to those who are averse to the risk of having to pay the mortgage off at the end.
It is a more popular choice for homeowners because of this. If you plan on keeping the property at the end of the mortgage term, you will be able to do so with a repayment mortgage as you will own it outright.
However, for landlords, the monthly payments will likely be much higher because of the capital payment side of things, and for those looking to make a healthy monthly income, this can be off-putting.
Things can change
Whatever choice you make as a landlord, you can always switch from interest-only to repayment, or vice versa, if your circumstances change. If your cashflow isn’t at its best, for example, you could switch to interest-only to lower your monthly repayments and get things back on track. Likewise, if your monthly budget allows higher outgoings, you could change to a repayment mortgage to get rid of some of the outstanding balance.
Like with any mortgage, you can normally make overpayments up to a certain amount, which should be set out by your lender, so having an interest-only mortgage but making additional payments when you can afford it to pay off the capital could also be a good option for many landlords.
