Interest-only buy to let mortgages check today's latest rates
Features of interest only buy to let mortgages
If you choose an interest-only mortgage:
- You will repay only the interest accrued on the loan balance each month.
- The loan balance, or capital, will not reduce
This means that, when comparing the same product on a ‘capital repayment’ basis with an interest only repayment, your monthly payments will be cheaper.
However, once your mortgage term comes to an end, the full loan amount (capital) will be due. For this reason, you must make separate provisions to repay this balance in full, known as an 'exit strategy'.
An exit strategy might be to sell the property, or pay off the capital from an alternative source of funds.
What benefits does an interest-only buy to let mortgage provide?
- Lower monthly BTL mortgage repayments mean more monthly cash flow, which you can reinvest to grow the value of your portfolio. Cash is much more accessible than equity in a property.
- Most buy to let mortgages have overpayment facilities, where this is the case you could choose to overpay to reduce the capital, without the commitment of having to under the terms of the mortgage contract.
- Depending on your tax status, you may be able to claim relief or a reduction for your mortgage interest. (See below.)
What are the drawbacks of an interest-only buy to let mortgage?
- You are not paying off the capital, so you will still have a debt to repay at the end of the mortgage term.
- In light of the above, you will not own the property at the end of the mortgage term
- If house prices were to fall, you may not have the money at the point of sale to repay the debt
These factors contribute to an interest-only investment commonly being a long-term strategy, so whilst you are not repaying capital, you look to achieve rental repayments that give you an income, after business costs and maintenance.
Similarly, over longer periods of time, the fluctuation in house prices may offer you capital growth – but this is more likely to be over a period of many years.
Extra cash flow allows you to prepare for emergencies
Contingency funds are crucial for landlords. It is your responsibility to pay for a lot of maintenance work and repairs in your property. You may also encounter periods where your tenant stops paying rent (arrears) or your property is empty (voids).
The extra cash flow afforded by an interest-only mortgage can be very useful in this regard. By setting some aside each month, you will build a contingency fund that you can dip into during emergencies.
Operating income is necessary for any business, and buy to let is no different.
To make an interest-only buy to let mortgage work, you need an exit strategy
Your ‘exit strategy’ is how you plan to repay your loan at the end of the term. Depending on your long-term goals, there are one or more ways to do this.
Some investors will sell their property. If its value has appreciated enough, they will be able to pay off the loan and still enjoy a lump sum return. (Remember that sales profits are taxable. Read our guide to capital gains tax for more information.)
On the other hand, some investors want an asset that they own outright. They might wish to pass on an unencumbered property to a family member, or boost their retirement income. These individuals will need to find the funds elsewhere.
If this is the strategy you intend to take, discuss this with your advisor.
Can you claim tax relief on buy to let mortgage interest?
As well as boosting your cash flow, interest-only buy to let mortgages can be tax efficient. This is because some landlords can claim relief or reductions on the tax they pay on their rental income.
If you invest through a limited company, all mortgage interest is tax deductible. For every pound your company earns, it will save 20 pence in corporation tax.
Finance cost relief is more complicated for private individuals. Until April 2017, all interest was deductible. However, the deductible portion is falling by 25% per year, until it reaches 0% in April 2020. From April 2020, landlords will be able to claim a 20% reduction on the non-deductible portion.
If you haven’t already, be sure to consult with a tax advisor to find out what effect the new tax rules might have on your business.
Talk to an advisor by calling us on the number above or enquire online today.