Historically, getting a mortgage means borrowing a sum from the lender and paying the amount back over a certain period, usually 25 years. Each month, you pay off part of the amount borrowed plus the interest on the loan.
But what happens when you only pay the interest and not the money borrowed? Sounds crazy, right? Well, it is, and it isn’t. There isn’t much to gain from an interest-only mortgage if you’re buying a residential home. When it comes to buy-to-let, however, the landscape is somewhat different. Buy-to-let mortgages that are interest-only can be beneficial.
So should you get one? We’ve put this guide together explaining why buy-to-let mortgages tend to be interest-only and what that could mean for you as a landlord.
Buy-to-let mortgages that are interest-only
The majority of buy-to-let mortgages are interest-only because you pay the interest and nothing else. Doing so makes your monthly repayments lower, which means your profit margins for the rent received are higher than if your mortgage was on a repayment plan.
Once upon a time, there were also tax advantages to claiming the interest on mortgages when filing a tax return. However, that has since been capped to a standard 20 per cent after changes made in 2016.
Are most buy-to-let mortgages interest only?
The short answer is yes. A survey by the NLRA (which is an acronym for the National Landlords Association) reports that most landlords choose buy-to-let mortgages that are interest-only when purchasing their investment. That means you don’t pay back the amount borrowed for the mortgage.
Instead, you only pay the interest on the loan. This is because the rental income covers the monthly interest, and most landlords see buy-to-let as a long-term investment that accumulates wealth over time. Essentially, the idea is to make a monthly income from the rent while the property’s value increases.
But how do I pay back the mortgage?
Whether you’re investing in bricks and mortar or cryptocurrency (thanks, Elon), the name of the game is to see your asset appreciate in value over time. Buy-to-let is an investment vehicle, and when it comes to property, anyone investing hopes to see the value of their house increase.
For most landlords, owning a buy-to-let is a long-term investment, with property prices historically going up over a long period of time. Of course, there’s no guarantee, but the term “safe as houses” wasn’t coined out of market volatility in the property sector.
Lenders will ask how you plan to pay back the loan at the end of the term on buy-to-let mortgages that are interest-only. Most landlords list “sale of the property”, but you can include other investments, too.
When it actually comes to paying off the mortgage in full, there’s a good chance that the property will have seen its value increase. So you’d pay off the mortgage with the sale of the home and keep the profit from its value increase (just remember that you will need to pay capital gains tax).
Alternatively, you could extend the mortgage for a longer-term if you had no desire to sell the property. Then there are different assets, such as other properties or investments that you may wish to cash in on to fund the mortgage.
Are buy-to-let mortgages that are interest-only a good idea?
While we can’t tell you if an interest-only mortgage is a good idea (everyone’s circumstances are different), it’s not uncommon to see landlords opting for an option where they only pay back the interest.
If you decide to get a repayment mortgage for your buy-to-let, the profit margins will be tight and possibly even non-existent. On the plus side, you will pay off your buy-to-let faster.
Here’s an example of a financial breakdown of repayment and interest-only buy-to-let mortgage:
|Property price: £350,000
Deposit: £86,000 (75% LTV)
|Property price: £350,000
Deposit: £86,000 (75% LTV)
|Monthly repayments on a two-year fixed at 3.10%: £1,266||Monthly repayments on an interest-only two-year fixed at 3.10%: £682|
|Monthly rental payments: £1,500||Monthly rental payments: £1,500|
|Leftover income: £234||Leftover income: £818|
**Numbers are indicative and taken from Moneysupermarket
As you can see, the interest-only option leaves you with considerably more income once the mortgage payment is deducted. That’s because the monthly repayment is lower, as you’re only paying the interest.
What else should I know about interest-only and repayment mortgages?
There are some risks to getting an interest-only mortgage. If house prices fall, you’ll have to make up the difference when it comes to repaying the debt. Fortunately, it’s rare to see house prices drop, but as the financial crisis of 2008 – the last time prices fell – taught us, anything can happen.
However, because most landlords are in property investment for the long term and expect to ride the ups and downs, they often feel more confident banking on buy-to-let mortgages that are interest-only.
Finding interest interesting
Now that you have a clear understanding of how interest-only mortgages work in regards to buy-to-let, why not look at the digital mortgages on offer at Molo? We have a range of products, whether you’re buying as an individual, SPV or HMO. You can find an interest-only product that suits your buy-to-let needs.