My partner and I are in the process of buying our first buy-to-let property investment.
Whilst arranging the mortgage, our broker asked if we had considered an interest-only deal. Apparently this is quite common in buy-to-let?
Having looked at the figures, it would mean we would be paying only £190 a month.
This is significantly less than the £503 we would pay if we opted for a capital repayment mortgage with a 25-year term.
It’s certainly tempting as we could really do with the extra cash. And if we wanted to purchase another buy-to-let in future, this would make it easier to save the deposit.
An interest-only mortgage should only be considered as an option if a borrower has a viable repayment plan, such as selling the property at the end of the mortgage term
However, my partner and I are uneasy at the prospect of having such a large debt just sitting there not being paid off, and we’re worried it will come back to haunt us further down the line.
Our broker says we can just sell the property at the end of the term to pay off the mortgage. But equally we might not want to sell.
What would you advise we do? Would it be reckless to opt for an interest-only deal? Via email
Ed Magnus of This is Money replies: Interest-only mortgages are popular with many buy-to-let investors because it increases their overall cash flow.
With less of the rental income going towards paying off the mortgage each month, they can build up their savings faster than they might otherwise have done, enabling them to buy their next property sooner.
With an interest-only mortgage, you will only pay the interest each month, with the loan amount remaining the same.
This differs from a typical repayment mortgage where you will pay back a part of the loan, as well as the interest, each month until you eventually pay off the mortgage.
With interest-only, your monthly payments will be lower, but at the end of the mortgage term, the full amount you borrowed will need to be repaid in one lump sum.
Most mortgage deals allow borrowers to make overpayments of 10 per cent of the total mortgage amount each year without incurring penalty charges.
This means that, in theory, you could use an interest-only mortgage and still pay off the debt in lump sum payments over 10 years or more.
But an interest-only mortgage should only be considered as an option if a borrower has a viable repayment plan and understands the risks involved.
The main issue for most mortgage lenders is how a borrower plans to pay back the mortgage.
The most popular option is to pay off the mortgage via the sale of the property at the end of the mortgage term.
But equally if the borrower can prove they already have sufficient cash, stocks and shares or another property that they would be prepared to sell, then these will be accepted as repayment options by most lenders.
Interest-only mortgages certainly won’t be for everyone and a lot will depend on your appetite for risk, your relationship with managing debt and whether you intend to purchase additional buy-to-lets in the future.
Taking an interest-only mortgage would leave our reader with more cash to play with each month – but they are worried having such a large debt may not be a good idea
Lower monthly payments might be the big temptation for many people, but it is also possible to lower the monthly costs of a repayment mortgage by extending the term, so it may be worth considering this as well.
To help in answering our reader’s conundrum, we spoke to Rob Bence, co-founder and chief executive at Property Hub, and Chris Sykes, associate director and mortgage consultant at Private Finance.
Rob Bence replies: Practically, there’s always the option of making capital repayments when you have an interest-only mortgage – up to a maximum percentage – each year, or in ‘chunks’ when remortgaging.
If someone wants to be a portfolio landlord, they will more often than not opt for interest-only mortgage, in order to have greater cashflow in their portfolio
Chris Sykes, mortgage consultant
Meanwhile, there isn’t the alternative option of deciding not to make capital repayments when you have a repayment mortgage.
For that reason, interest-only offers greater flexibility and is generally preferable.
However, some investors may value the psychological benefits of paying down the mortgage on an enforced schedule more than they value flexibility.
Chris Sykes replies: It depends on an individual’s personal goals. If they just want one or two buy-to-lets, then potentially a capital repayment mortgage is a good route to go down.
But if someone wants to be a portfolio landlord, they will more often than not opt for interest-only mortgage, in order to have greater cashflow in their portfolio.
Once someone is a portfolio landlord, lenders start to stress test their background portfolio – and if they are on a capital repayment mortgage then it could limit the number of lenders they could use moving forward.
It may be that their portfolio fails a lender’s stress test because they are committed to the higher repayments associated with paying down the mortgage each month.
If for example there were rental voids associated with their other buy-to-let properties, this might compromise their ability to maintain their monthly mortgage payments.
The lender therefore may deem there to be insufficient liquidity to offer them a further mortgage.
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