As we’ve mentioned in previous blog articles, we recommend interest-only mortgages to our property investors in the majority of cases. With mortgages like this posing some unique benefits and risks compared to standard capital repayment mortgages, it’s time to dispel some myths around taking out loans on an interest-only basis. In today’s article, we’ll go over what taking out a mortgage like this entails and how to tell whether it’s the right option for you.
Interest-only vs. capital repayment mortgages
We’re all familiar with repayment mortgages: when you take out one, you commit to making monthly repayments that cover the interest on your loan as well as repaying the capital you’ve borrowed in steady instalments throughout the term of your mortgage so that at the end of it, you own your property outright.
With an interest-only mortgage, you’re essentially “renting” the capital needed for the duration of your investment, the “rent” being the interest you pay to your lender monthly. At the end of your mortgage term, you’ll still owe the original amount of money you borrowed unless you’ve made occasional lump sum repayments throughout the duration of your mortgage.
Repayment plans for interest-only mortgages
In order to qualify for financing on an interest-only basis for a residential mortgage, you’ll need to present a credible repayment plan for the capital you want to borrow to your potential lender. This could be made up of things like savings, other investments, an endowment policy you can cash in or a pension payout.
While you might plan on reselling your property to repay your mortgage, you’ll need to prove you’re able to repay the mortgage even if you want to retain ownership of the property at the end of your mortgage term or aren’t able to make enough in the sale of it to cover the mortgage repayment.
That being said, the majority of deals available to buy-to-let investors count rental income and the sale of the property at the end of the mortgage term as a sufficient repayment strategy.
Interest-only financing does pose some additional risks when compared to capital repayment mortgages. There is the small possibility of your investment property dropping in value during your mortgage term (more on this later). Additionally, you might face difficulties in paying a large lump sum back to your lender at the end of your mortgage term if something unexpected has happened with your repayment plan.
Why we recommend interest-only mortgages to our investors
We recommend taking out a mortgage on an interest-only basis to the majority of our buy-to-let investors because of the flexibility and cash flow this offers. With lower monthly repayments, you get to keep more of their monthly rental income and do with it as you please: save it up to make lump sum repayments on your interest-only BTL mortgage, stow it away for a rainy day or reinvest it in additional properties to grow your portfolio.
This level of flexibility is also hugely helpful in leaner times throughout your investment term: if your rental property sits vacant for a period of time or some unexpected repair needs come up, the lower monthly mortgage payments mean your cash flow will suffer a lesser blow.
Additionally, while at the end of your interest-only mortgage term you can pay back the capital you initially borrowed in order to own the property outright, you could also sell the property in order to repay your mortgage and move onto your next investment. This makes interest-only financing so good for investors, as owning a buy-to-let property outright for decades is usually not their main goal.
Many people are wary of interest-only financing because they fear property prices will decrease over the years. However, it’s good to remember that this is highly unlikely over the period of 25 years – the standard term for mortgages.
And even if this turns out to be the case, inflation can help you out: for example, £100,000 in 1990 was worth an impressive £224,000 in 2015. This is irrespective of the fall in property prices in the 1990s and in 2008. And even in the unlikely event that your property does fall in value, you’ll likely only lose your initial downpayment at most, while still receiving a monthly cash-flow from your initial investment.
Which one is right for me?
With all of this being said, there’s nothing wrong with repayment mortgages and they may work for a certain type of property investor. Especially if you’re older and would like to leave mortgage-free property to family in your will, a repayment mortgage might be a better fit for you. A repayment mortgage is also better for you if you are risk-averse and your main interest is capital growth.
It should also be said that in most cases, interest-only financing is not the best option for residential mortgages because the associated risks are higher, especially if the property is your main residence. This is true especially if you want to move to a different property at the end of your mortgage term, as you’ll have to get together enough capital to pay off your mortgage and purchase a suitable new home.
That being said, if your income is largely made up of large periodic lump sums from things like bonuses and commission, the flexibility an interest-only mortgage offers could be right for your home.
Finally, if you’re a property investor whose main goal is generating a steady income from your buy-to-let property, taking out a loan on an interest-only basis is the best option: it gives you superior cash flow as well as the flexibility you need to maintain and further expand your property portfolio.
If and when you do decide to sell your property, you’ll most likely be able to make a healthy profit from the sale due to property price inflation even after paying off your borrowed capital.
Part-and-part mortgages: the middle ground
There is an additional option for those who want to combine the best of both worlds: part-and-part mortgages. This is exactly what it sounds like: part of your mortgage will be on an interest-only basis and the other part will take the form of capital repayment.
Your monthly payments will be higher than they would be than with interest-only financing, but lower than with a pure capital repayment mortgage. At the end of your mortgage term, you’ll still owe your lender part of the capital borrowed, but you’ll have already paid off a sizeable chunk of it.
The bottom line
The right type of mortgage product for you is highly dependent on your financial standing and goals for your investment, which can make figuring out what the right financing option for your investment is difficult. Luckily, our impartial, whole-of-market mortgage brokers are highly experienced in offering highly personalised property investment and mortgage advice, whether you’re investing in property for the first time, have a large property portfolio or want to purchase your dream family home.
To get our expert financial advice and find out whether an interest-only mortgage could be right for you, get in touch with us.