Landlord conundrum – interest only vs. repayment mortgage?

April 13, 2017

For many landlords, when starting out on their investment career, if they are not cash buyers, there is an important decision to be made.

Should the landlord opt for an interest-only or a repayment BTL (buy to let) mortgage?

The answer will be very personal to the landlord, their financial situation, their attitude to risk, and the reason why they have invested in property.

In truth, there is no right or wrong answer, just what is best suited to the landlord’s situation.

A reputable mortgage broker will be able to advise, but, as a rule the vast majority of landlords opt for interest-only mortgages for the following reasons:

1.  The monthly repayment will be significantly lower, thereby meaning more positive net cash flow per month.  If the landlord intends to hold on to their investment for a significant time period – 20 to 30 years – then it is likely that the property will go up in value over time, meaning that the landlord can exit the property via sale and repay the capital at the end of the term and still enjoy some residual gain after paying capital gains tax.

2.  The way loans are constructed, with a repayment mortgage, you are only paying off the interest for around the first half of the loan.  Therefore you are not biting into the capital, but still making a significantly higher monthly payment, reducing net cash flow month on month.

3.  An interest-only mortgage is more flexible.  You can save excess cash from the rent over, say, a 5 year period, and then use that lump sum to pay off some of the capital.  Lenders typically allow an over-payment of up to 10% per annum.

4.  Using interest-only mortgages may allow you to build up a portfolio more quickly as you could use excess cash or re-mortgaging up to a new LTV when the property has increased in value, to build up deposits for further purchases.  This is known as “leveraging” or “gearing” and allows a small amount of money (your deposit) to take control of a larger amount of money – lent by the lender.

Some circumstances when you may choose a repayment BTL mortgage:

1.  You have significant other income and don’t need the monthly cash flow.

2.  You are very risk averse.

3.  You are working to shorter time-frames.

4.  You want to end your investing career with unencumbered properties (mortgages paid off) to live off the income in your retirement.

For some landlords, a combination of interest-only and repayment mortgages may give them the best of both worlds and hedge risk.

One interesting point to note is that, in the past, interest-only mortgages were often chosen by landlords for being more “tax efficient”.  However, due to the advent of Section 24, which came into effect on the 6th April 2017, this may now not be the case, particularly for higher rate tax payers on the full implementation of Section 24 by 2020.

It may be advisable for them to buy their properties within a limited company format, to mitigate the impact of Section 24.

If buying in their own name and using BTL finance, it will certainly be advisable to opt for a lower loan to value, which means putting in a larger deposit.  Going forwards, we expect most sole trader landlords to be gearing below 60%.

One thing is certain … The best thing all new landlords can do is speak to a reputable mortgage broker and tax advisor before making their first acquisition.  Your local Northwood office would be happy to make appropriate introductions and also assist you with purchasing an investment property that suits your personal situation.

Don’t forget, you can also check out our “Investor List” of properties suited to investment, some of which are already tenanted, meaning you make an income from Day One of ownership!

Northwood is one of the largest and most recognised estate agents in the U.K. and the leading supplier of Guaranteed Rent to give landlords complete peace of mind.

Find us on Twitter @northwoodUK or visit our YouTube Channel.

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