Interest only or Repayment BuytoLet mortgages

Interest only or Repayment BuytoLet mortgages

12:51 PM, 24th May 2013, About 9 years ago 20

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Ying and Yang imageA common question from new Landlords is why are so many BuytoLet mortgages taken out on an Interest only basis rather than Capital and Repayment.

First of all it helps to understand that a BuytoLet mortgage seems very similar to a Residential mortgage, but it is not regulated in the same way by the Financial Conduct Authority FCA (the FCA has now replaced the FSA). This is because it is treated as a commercial loan, and investors are assumed to have a greater understanding of the commitments they are entering into than someone who may have no financial understanding buying their own main residence. The key is that a BuytoLet is seen by regulators as a business loan and BuytoLet investors should treat their property purchases using a mortgage as a business themselves.

If you were to offer any business, no matter what the industry, the option of:

  • a loan on Interest only with lower monthly payments or
  • a capital and repayment loan with higher monthly commitments but a reducing balance

Nearly every business would choose Interest only, because as the saying goes “Cashflow is King”

Now in practical terms, the biggest risk to a landlord is not being able to make the monthly mortgage payments. Therefore this risk is reduced using Interest only.

But what about reducing the loan size I hear you cry.

Interest only should hopefully produce a cash flow surplus on a reasonable yielding property and this should then be saved in a separate account for a rainy day to cover future mortgage payments, or used at your convenience to pay lump sums off the mortgage when there are no redemption penalties.

The control is now in your hands and not the lenders, vastly reducing your exposure to risk. If you take out an interest only loan it is easy to get the lender to convert this to Capital and Repayment, but the reverse is true with lenders being reluctant to convert a mortgage to interest only from Capital Repayment when you need to.

If you are sensible and treat all your rental income as part of the business e.g. don’t rush out on holidays or buy a Ferrari, you can now manage your cash flow and total debt outstanding yourself.

It is important to note that this strategy is not available or right in all circumstances, but a summary of why it is extremely popular for BuytoLet investors.

If you would like to view the most popular Buytolet mortgages available in the market today, see how much you can borrow and what it would cost please feel free to CLICK HERE for our BuytoLet mortgage calculator.



Comments

23:24 PM, 29th May 2013, About 9 years ago

It's a balance between risk and reward.

One approach would be purely to buy one at a time, pay down debt as quickly as possible and then once mortgage free start saving up the deposit for the next one. That should be the lowest risk approach (as long as you can cover voids) although it will also be the slowest way to build a portfolio.

At the other end is the interest only approach where every property is fully leveraged, no attempts are made to repay any of the debt. This approach clearly has the potential to generate a much larger portfolio although will generate very large amounts of mortgage debt, and annual profit levels will be lower, so repayment will require sale of some of the portfolio (which will probably lead to a fair bit of CGT at the time too).

Somewhere in between those two approaches is mine. I only buy when I have sufficient other assets available for deposit and have mortgages on a repayment basis so that the debt is falling by a noticeable amount every month. Knowing that the debt is falling all the time does provide a certain comfort level that I wouldn't have with a full balance still outstanding.
(To be fair, there have been one or two occasions when I have reasonably seriously considered capital raising for a particular property, but in the end, for various reasons haven't done so).

This approach broadly matches my risk profile, and means that I'm on course for a reasonable income in not too many more years without having to worry about mortgage repayment.

Mark Alexander - Founder of Property118 View Profile

8:37 AM, 30th May 2013, About 9 years ago

@Repaymentfan - if I were to sell enough of my properties to repay all debts my net rental income would be lower than it is today. I would also look upon that as being a very risky strategy because when property values go up I would miss out on the opportunity to refinance and release extra cash. If they go down in value it's just a paper loss as my cashflow would remain unchanged. The other problem will selling, as you rightly point out, is CGT. My plan is never to sell. CGT is not payable after death, which is a bummer of a way of getting out of paying tax I know and not to be recommended! LOL. What comes after death of course is IHT. High gearing can help with this too.

Howard Reuben CeMap CeRER

19:07 PM, 7th July 2013, About 9 years ago

Hi Mark - just noticed this thread!

"What comes after death of course is IHT. High gearing can help with this too." Yes, you're absolutely right, however whatever the gearing, clever life cover planning and will writing / estate planning (including life cover in Trust etc) is also an extremely helpful tool for IHT planning too.

People are usually expect very high premiums for this level of cover - but most are very surprised to know how little it actually costs!

Mark Alexander - Founder of Property118 View Profile

11:10 AM, 28th July 2013, About 9 years ago


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Jeremy996

10:17 AM, 30th July 2013, About 9 years ago

My view is if you are running a proper business, then Interest Only is a valid financing option; it certainly simplifies the annual tax return!

Where things go wrong is an assumption that all 'spare' cash is available for spending. More businesses go bust for lack of cash rather than lack of assets and a repayment mortgage enforces a savings programme for the weak minded. Even this is not foolproof, as extracting the equity will need co-operation from the lender or a remortgage.

For accidental/hobby landlords a repayment mortgage is a useful default, but anyone else needs to consider attitude to risk, cash needs, CGT and the availablity of loans.

I would suggest that assuming immortality is not the best planning point. Once you get past 5 properties held personally, I would explore setting up a property management and holding company as this gives access to a number of tax planning and control alternatives.

Mark Alexander - Founder of Property118 View Profile

10:54 AM, 30th July 2013, About 9 years ago

Reply to the comment left by "Jeremy Edwards" at "30/07/2013 - 10:17":

Interesting you mention tax structures and using companies Jeremy. When I looked into this it was far more efficient for me to remain a sole trader. I documented my strategy here. Please feel free to comment upon it >>> http://www.property118.com/is-your-property-portfolio-ownership-structure-optimised/201/
.

t pelosi

22:29 PM, 17th August 2013, About 9 years ago

hi, very interesting
,am just thinking if I should pay down myIO BTL mortgage with All rental income monthly,or stick to usual monthly payment and save etc.does anyone know how this affects tax if I overpay monthly to pay down IO mortgage.many thanks for your comments Tessa

Mark Alexander - Founder of Property118 View Profile

22:37 PM, 17th August 2013, About 9 years ago

Reply to the comment left by "t pelosi" at "17/08/2013 - 22:29":

You can only offset mortgage interest against rental income, NOT overpayments.

Please read this article >>> http://www.property118.com/what-you-shouldnt-do-with-your-buy-to-let-mortgage/
.

Ritchie Stott

12:40 PM, 26th August 2013, About 9 years ago

Reply to the comment left by "Mark Alexander" at "24/05/2013 - 13:01":

You have started to answer a question I was not sure about
I have a BTL mortgage on a rental property
Our rental property's are our retirement income so at present whilst working we pay income tax on the earnings as our personal allowances are offset against our jobs.

If for example I pay a £250 month mortgage interest only
Does that mean I am then not paying income tax on £250 a month of the income of is there a bizarre calculation for it all .
Would I be better off using my savings to clear the mortgage or not ? Confused I am

Neil Patterson View Profile

18:17 PM, 26th August 2013, About 9 years ago

Hi Ritchie,

You are correct that the BTL mortgage interest comes of your business income as a cost before tax.

However as the invest property is being used for your retirement planning please do not accept any pension advice from any one other than an FCA qualified IFA who has been through a full fact find with you.

If you would like to speak to an IFA and have any specific personal questions please do not hesitate to email me off line.

npatterson@property118.com

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