If you are an experienced landlord, you will be familiar with the idea of an interest-only buy to let mortgage. If you are taking on a rental property for the first time, these loans are worthy of your consideration.
By only making interest payments on your loan, you will be able to keep your monthly payments low over the course of your mortgage term. To this end, keeping your mortgages interest-only opens up opportunities to buy multiple properties and keep your income flowing.
Not every buy to let mortgage is interest-only, and not every interest only loan needs to be an investment. All the same, it’s typically landlords that seek the help of a mortgage advisor when seeking to buy homes this way. When it comes to mortgages, interest-only is an option but not a necessity.
It’s best to look for a buy to let mortgage on interest only grounds if you plan to sell the building after a year or two. You’ll need to settle your balance after a short mortgage term, but at this point you can sell for a profit and enjoy financial advantage from the sale if the amount you make exceeds what you paid.
What is an interest-only buy to let mortgage?
A buy to let mortgage comes with different terms and conditions than the loans associated with a more traditional mortgage. One option open to any aspiring landlord that plans to invest in a buy to let property as an investment is an interest-only buy to let mortgage.
If you take out this loan – available through high street banks and specialist lenders alike – the amount of your repayment terms will be lower on a monthly basis. If you have an interest only mortgage, you will only pay back the interest on the account each month, without making payments on the capital.
On paper, this is great news. The costs can quickly rack up when you buy a property, and any opportunity to save money – especially if you bring in plenty of income from your rental yield – will be welcomed. Smaller mortgage repayments are never anything to sniff at.
Just be aware that you will need to repay the full balance at the end of your mortgage term. It’s highly advisable to have a savings plan in situ, so you can use your income – whether from your rental property, your job, or both – to ensure that your interest only mortgage does not end up leading to a loan you cannot afford to repay.
Why do landlords favour interest only mortgages?
As discussed above, the biggest advantage of an interest only buy to let mortgage is reducing your monthly repayment amount. It’s not a free hit on the loan – you’ll need to repay the balance in full after a couple of years – but the financial freedom afforded by a mortgage of this kind will provide greater flexibility.
If you take out a buy to let mortgage with a view to ‘flip’ the property and sell it for a profit in a the futre, an interest-only mortgage is particularly effective. You can turn a profit on your purchase price, and use the rental yield to further bolster your bank balance. Provided you sell the home before the end of the mortgage term, you’ll have no trouble settling up the loan balance.
By making smaller repayments each month, you’ll also have more money available for investment. If you want to take on multiple buy to let properties, you can use an interest-only mortgage model to finance these purchases and keep a steady income.
Not everybody feels comfortable with the decision to buy multiple properties, but if that’s a financial model that works for you, seriously consider an interest-only mortgage.
Of course, this means that a buy to let interest only mortgage comes with an element of risk. If the property decreases in value, or you end up spending more on repairs and improvements than you were expecting, you may find yourself in a weaker financial position than you intended.
Choose wisely and take time to plan when considering your mortgage options.
Are all buy to let mortgages interest-only for rental properties?
Not at all – you will be welcome to apply for a repayment mortgage on your investment properties if you prefer. Capital repayment mortgages cost more than interest only mortgages in terms of monthly repayments.
As such, it can make it harder to meet the affordability criteria of btl mortgage lenders when applying on a capital repayment basis.
As we have previously discussed, this kind of mortgage is the choice of most landlords that are seeking a buy to let mortgage. You’ll always have a choice, though, so do not take on an agreement that you do not feel comfortable with or an amount that you are worried you will not be able to afford in the longer term.
Can I use a mortgage calculator for buy to let mortgage interest only lending?
ABC Finance offers a mortgage calculator for prospective buy to let applicants. This calculator can be used for interest-only purchases or capital repayment mortgages, you will get an idea of what sum you may be looking at repaying each month with loans of this ilk.
Always remember that a mortgage calculator of any type is not an exact science, and should not be considered anything more than a guideline. Interest rates that you are offered by lenders, and the sum of the deposit amount you need to lay down, will vary according to your unique circumstances, such as income and credit history, and cannot be accurately predicted by a calculator.
What are the benefits of interest only BTL mortgages?
If you are yet to be convinced that a buy to let mortgage for your rental property is the way forward, let’s reiterate the advantages of this kind of loan.
Lower monthly payment
We have said this numerous times already, but a good point bears repeating. Taking out a mortgage on an interest only basis means that you will be repaying a smaller fee amount on your loan every month than you would with a traditional repayment mortgage. Everybody likes the idea of achieving maximum reward in exchange for minimal outgoings, right?
Imagine that you agree to a 25-year repayment mortgage for £150.000, at an interest rate of 5%. You will be left paying £876.89 each month on this basis. If you take out the same loan on an interest-only arrangement, your repayments will drop by at least £200. If you bring in a rental yield of around £1,000 per month, in addition to a standard income, you will have plenty of money to set aside in a savings plan to ensure you can settle the balance at the end of your term.
If that is going to be a problem, some lenders will also consider allowing you remortgage on identical interest only terms. Discuss this with a mortgage advisor, ensuring that you are getting the best deal and continue to flourish on the basis of your buy to let mortgage investments.
It’s tax efficient to take out an interest only loan
As the popular idiom claims, death and taxes are the only two certainties in life. Property investment will attract the attention of HMRC, and you’ll need to pay tax on any money you make as a landlord. Thankfully, there are ways that you can turn this to your advantage and loans issued on an interest only basis to gain tax breaks.
Let’s be clear about one thing – interest payments on your mortgage are not considered tax-deductible expenses any longer, so you will not be able to write the full amount off and consider your property pure profit. However, you will be entitled to a reduction of 20% on your income tax payable.
This means that, should you plan to rent your property for £1,000 per month, you’ll be liable for £12,000 in tax repayments. Knock 20% off this, and you’ll be paying £9,600 in tax. An interest-only mortgage that costs you £650 per month in repayments will total £7,800, so your taxation responsibilities will be very low in comparison to those made on a repayment mortgage.
if you’re especially smart with your investments, you may even be able to neutralise your tax commitments – though it’s highly recommended that you discuss any intentions in detail with a mortgage advisor and draw up a plan that ensures you will not fall foul of tax avoidance or evasion charges, which can become extremely expensive and stressful if you are audited.
You may qualify for a larger loan on your mortgage
The total value of a property will have a substantial impact on which investment home you plan to buy and use for rental yield. Bigger is always better, as a property with a higher market value will also attract a substantial amount from aspiring tenants.
Of course, there will always be restrictions placed on this in the name of affordability. By taking out an interest only mortgage, and this making smaller repayments on a monthly basis, you’ll be able to plan a little bigger and buy a larger property that may otherwise be out of reach.
As always, you’ll need to ensure you are making a fiscally sensible decision here. Never lose sight of the fact that you’ll need to settle the loan eventually, so do not put yourself in an awkward position where you will have a substantial debt that you simply cannot afford to service.
All the same, if you use the market smartly – and obtain sound advice from a professional mortgage advisor – you can turn the market to your advantage. Bringing in income through rent from your tenants can be a great way to bolster your bank balance and create a substantial passive income.
Keeps mortgage funds free to cover the cost of repairs
When taking out a mortgage, many people look for the biggest loan they can afford on the open market. That’s fine, but it can leave you struggling for the financial power to make improvements to a property. These improvements could be necessary to ensure the home meets the minimum standards required by law, or they could help you charge a little more in rent.
As you’ll only be repaying the interest amount on the property, affordability will be different from that of a repayment mortgage. If you are looking to sell the property, lenders may also welcome the opportunity to loan you more than the existing market value of the home. Banks are keen to make money too, and the lender trusts that you will turn a profit, they will consider a higher loan to be a risk worth taking.
You will need to prove that you will be able to meet these repayments as standard, and a lender may also ask to see a business model that demonstrates some kind of evidence that you’ll be able to sell the property at the maximum value in order to turn this profit. If you make the effort to produce this, you can reap some substantial rewards.
Keep reading – Limited company buy to let mortgage
What are the disadvantages of a buy to let mortgage?
Not everybody will find that an interest-only mortgage works for their needs – you may be better served with a more traditional repayment mortgage. Here are some concerns to keep in mind when weighing up your loan options.
You’ll still owe the full balance at the end of the term
By far the biggest consideration when taking out an agreement on a buy to let basis is how much you will need to pay at the end of the term. While your monthly repayments will be reduced, you’ll remain on the hook for a lump sum when the mortgage term comes to an end.
If you go into this agreement with your eyes open, this should not be too big a concern. You will have a clearly defined payment schedule, so you’ll know exactly how much you need to save and when you’ll need to pay the full debt back.
If you fail to do so, you risk repossession of the property. This means that you’ve wasted money on interest payments and received nothing in return, while your tenants will also be inconvenienced.
Lenders will not lend to just anybody – your financial situation will be assessed, and you’ll need to provide evidence that you can settle your balance as well as make mortgage repayments – but ultimately the responsibility lies with you.
Do not take on a commitment that you cannot afford to honour, relying on being able to take out a buy to let remortgage if you run into trouble. Advice is freely available from ABC Finance if you are unsure if this is a sensible investment model for you.
You pay more interest over the mortgage term
When you first look at the repayment commitment that you’re taking on with this kind of loan, your eyes will likely light up. There is no denying that an interest only approach looks better on paper, especially as you’ll be paying less in monthly overheads.
Do not overlook the long-term impact of interest-only when considering your options, though. Unless you can keep the mortgage term extremely short, you’ll potentially pay more in the longer term, especially as the interest rate may be higher than those found on the open market.
As always, we strongly recommend using a mortgage calculator to ensure your plans are feasible – and double up on your research by seeking professional advice. If something looks too good to be true, it more than likely is.
What interest rates will I pay if I buy a property on a buy to let basis?
One thing that should be noted is that loans taken out on an interest-only basis will likely attract higher interest rates than those for your main residence. Buy to let mortgages are already costlier, and interest only loans also carry a degree of risk for the lender as they are relying on you to pay back the full sum at the end of the agreed term. This will be tempered by the interest that you need to repay.
As always, your personal circumstances will dictate the interest rate that lenders are prepared to offer you. If you have a clean credit history, experience as a landlord, a reliable income from other sources, and evidence that your property will generate enough rental yield to cover the mortgage repayments – and more besides – you’ll receive a more appealing offer.
Talk to a mortgage advisor and discuss your needs and circumstances. While you will be welcome to approach a high street lender, and may also be accepted for borrowing from such a lender, professionals enjoy access to a range of additional suppliers and may be able to find a better deal that is not available to the general public on the open market.
Will I qualify for an interest-only buy to let mortgage?
If you are interested in a buy to let mortgage, you will need to prove that you meet the repayment terms laid out for this kind of credit. Different lenders will assign different rationales, so you’ll need to look into this ahead of time. Unsuccessful applications can have a negative impact on your credit score, which in turn make it harder to obtain a mortgage or other lines of credit in the future.
The good news is that, if you qualify for a buy to let mortgage in the first place, you’re actually likelier to be approved for an interest only loan. As we have been at pains to point out throughout this guide, loans of this type lead to lower repayments, which in turn means that you’re likelier to pass an affordability assessment.
To bolster your chances of a successful application, build a business plan that shows how you will repay the total balance of the mortgage at the end of the term. Having tenants lined up ahead of making the purchase will also aid your case, as this proves that you have a reliable source of rental yield. Prove that you can cover the repayments if your tenants unexpectedly leave, too.
How much deposit will I need to buy a home this way?
You should expect to pay a deposit of 20-25% when taking out an interest only buy to let mortgage.
Obviously, the more you can pay in advance, the better. This will reduce your monthly repayments and make your application more favourable to lenders. Punch your deposit into a mortgage calculator – you may be pleasantly surprised at the difference a higher deposit can make. If you run multiple properties on this basis, you can use the profit from one sale to finance your next.