Interest-Only Buy-to-Let Mortgages
If you're a landlord considering an investment property or seeking to rent out your existing home, the choice of a buy-to-let mortgage becomes integral. Specifically, the decision between a repayment or interest-only buy-to-let mortgage is a vital one.
Although your long-term goals and current circumstances will play a significant role in shaping your decision, it's essential to understand the distinctions between these two options and recognise why interest-only buy-to-let mortgages are more typically seen. To provide you with the fundamental details, we've put together this guide which covers:
What is an interest-only buy-to-let mortgage?
As the name suggests, an interest-only buy-to-let mortgage enables you to exclusively cover the interest on the loan, rather than the principal amount. The mortgage balance is usually settled at the end of the term, often through the sale of the property. Consequently, this structure leads to lower monthly mortgage payments when compared to a repayment mortgage.
Are all buy-to-let mortgages interest only?
While there is the alternative of choosing a repayment mortgage for your rental property, wherein you pay both the principal and the accrued interest each month, it's worth noting that this option naturally comes with higher monthly payments, in comparison to an interest-only mortgage. This cost differential is the key element which leads many landlords to prefer interest-only mortgages.
Specifically, landlords generally choose this approach to enhance their monthly investment income. The excess rental income generated can be directed towards funding further property acquisitions and sustaining their existing buy-to-let portfolio. Having said this, it's important to consider that with a repayment mortgage, you would fully own the property at the end of the term.
Most lenders offering buy-to-let mortgages provide both repayment and interest-only options. After all, the primary distinction between the two lies in how you repay the mortgage. However, it should be taken into account that some lenders exclusively offer interest-only buy-to-let mortgages.
Advantages of an interest-only buy-to-let mortgage vs. repayment
Lower monthly repayments
The chief benefit of going for an interest-only mortgage is in the significantly reduced monthly payments, providing landlords with higher rental profits. This financial flexibility not only enables a boost in monthly rental income but also allows for allocating additional funds towards maintenance, insurance, and various expenses like letting agent fees.
Furthermore, the augmented monthly rental income facilitates a faster expansion of property portfolios, as the surplus income can be reinvested into other property ventures.
Benefit from property price increases
Deciding to sell your buy-to-let property to settle your mortgage could be advantageous, especially considering potential increases in property prices. Unlike a repayment mortgage where the balance decreases over time, an interest-only mortgage maintains a fixed balance as you only pay interest. Upon selling the property, you stand to gain any remaining capital, a factor that can be particularly substantial for mortgages spanning a longer term such as 20+ years.
No minimum income requirements
Evaluating interest-only mortgages is typically simpler than assessing repayment mortgages. Many lenders don't impose strict income requirements for buy-to-let, relying on the property's rental income to cover mortgage payments. Meeting a minimum requirement of 125% of the mortgage payments with rental income is often sufficient for passing an affordability check.
On the other hand, repayment mortgage payments being higher can pose challenges in affordability assessments. While lenders consider rental income, demonstrating an income substantial enough to cover both your buy-to-let and any other mortgages is essential. And so, this feature of an interest-only mortgage can prove very beneficial if concerns arise about meeting a lender's affordability criteria.
Short-term safety net
Given the inherent uncertainties in the buy-to-let market, there can be periods when your property remains vacant, generating no rental income. Opting for a buy-to-let interest-only mortgage serves as a partial safeguard against this risk.
The lower monthly payments alleviate the financial burden during periods of vacancy, allowing you to manage cash flow more effectively without the strain of meeting higher repayment obligations each month when your rental property is not generating any profit.
Disadvantages of an interest-only buy-to-let mortgage
You won’t own the property when your mortgage term ends
The main drawback is that, by choosing an interest-only mortgage, you won't gain ownership of your investment property at the end of the mortgage term since you don't contribute to the reduction of the actual mortgage balance. As the mortgage matures, the outstanding balance persists, prompting many landlords to sell the property to settle the loan.
Despite the fact some lenders might permit capital repayments during the mortgage term, thus gradually reducing the balance, this option hinges on your specific lender and possible early repayment charges as outlined in your mortgage agreement.
You’ll pay more interest overall
If you go for an interest-only mortgage, then you’ll incur a higher total interest cost compared to a repayment mortgage because the mortgage balance remains constant throughout the term. In contrast, a repayment mortgage involves consistent payments towards the principal, resulting in a gradual reduction of the outstanding balance and, consequently, a decrease in the overall interest accrued over time.
You’ll need an exit strategy
As the end of your mortgage term approaches, it's necessary to have a well-thought-out exit strategy in place to settle the remaining balance. A common approach among landlords is to sell their investment properties when concluding the mortgage.
On this point, it's worth being mindful of potential risks, particularly if property prices experience a decline around the time of your intended sale, since this could require you to cover the shortfall. Though this risk exists, it is less likely to happen in cases of mortgages with terms exceeding 20 years.
Can I switch from a repayment to an interest-only buy-to-let mortgage?
While it is feasible to transition between a repayment and an interest-only mortgage, it's essential to confirm with your lender whether such a switch can be carried out without your incurring penalties. In the event that your lender imposes a penalty, you may face an early repayment charge.
Alternatively, as your current deal concludes, there's the option to explore remortgaging to a different buy-to-let arrangement with a more favourable rate, one which is structured on an interest-only basis.
Am I eligible for an interest-only buy-to-let mortgage?
The primary consideration for lenders revolves around assessing whether the expected rental value is sufficient to cover your mortgage obligations. Eligibility necessitates demonstrating that your rental income will meet or exceed 125% of your monthly mortgage. Buy-to-let criteria might vary among lenders, but meeting additional application requirements is likewise imperative.
For qualification, a deposit ranging from 20-25% is generally required, and lenders will scrutinise your credit score, income, and expenses to evaluate your financial management. In the case of adverse credit, specialist mortgages are accessible to you. Moreover, a prerequisite for most lenders is that applicants must be existing homeowners to secure a buy-to-let mortgage.
It should be said that hard credit checks leave a mark on your profile. As such, if you want to get a view of your credit history before you apply for a mortgage, you can use our free credit check tool (£14.99 per month after the free 30-day trial). Using it will help you to discern any potential mistakes or fraudulent activity on your profile, so that you can deal with such problems quickly and effectively. The trial and subscription can be cancelled at any time.
Speak to a buy-to-let mortgage broker
Interest-only mortgages might be widely favoured by investors for the benefits we’ve spoken on, but it's important to note that there are various types of buy-to-let mortgages, and the most popular choice may not necessarily be the ideal one for your circumstances.
Engaging with an advisor is crucial for a comprehensive discussion about your goals in getting a buy-to-let mortgage. Lenders offer different rates that require careful comparison. We at The Mortgage Genie are a team of expert mortgage brokers who are ready to assist you through this process, helping you to navigate all your options before identifying a suitable lender tailored to your specific situation.
For more information on how we can support you, be sure to get in touch with us today by calling 01915809890. And why not see how much you could borrow up to right now by using our buy-to-let mortgage calculator?
This information is a guide only and should not be relied on as a recommendation or advice that any particular mortgage is suitable for you. All mortgages are subject to the applicant(s) meeting the eligibility criteria of the specific lender. You should make an appointment to receive mortgage advice which will based on your needs and circumstances.