When 2013 took its final bow, it was to a mixed reception. Continued austerity, the climbing state pension age and stinging hikes in energy prices invited a few boos from the stalls, but a slight pickup in the economy and a last-minute fall in unemployment sent a couple of bouquets flying in the direction of the stage, too.
Convoluted metaphors aside, the economy is enjoying a little bit of a pickup. The markers that signify the ‘beginning of the end’ are falling into place; including the all-important fall in unemployment, which Mark Carney (the governor of the Bank of England) has signified will need to lower to 7.0% before he considers raising interest rates.
Any economic recovery is going to be tempered by caveats. Clichés such as ‘don’t run before you walk’ start to do the rounds, and there’s an element of wisdom to them: if the government and the Bank try to build too quickly on what they’ve achieved so far, the whole thing could come crashing down.
There are two threats, then, to a portfolio that is heavily geared with interest-only buy to let mortgages. One is the possibility of another housing crash brought on by over-eager stoking of the housing market. The other is the probability of interest rate rises.
So, should you switch to a buy to let repayment mortgage?
Some landlords don’t like interest-only mortgages, but a lot prefer them. Ultimately, it comes down to risk – less risk-averse landlords are happy to not tie up their cash in equity, despite the financial safety it would afford them.
As such, there are largely two perspectives from which you can approach the question ‘should I switch to a buy to let repayment mortgage?’ – a risk perspective, and an investment perspective.
Risk of interest only mortgages
Interest-only is always the more risky route.
Firstly, it means that you need to pay off the entirety of the capital at the end of the loan. If an investment vehicle intended to do that falls through, then you’re reliant on the sale of the property (which scuppers any other plans you might have had for it).
Overall you could find the interest charged is higher
Secondly, whilst the monthly repayments are smaller, the total amount of interest payable is higher. The monthly payments also suffer more from interest rate increases, as they will affect the whole repayment, rather than just a proportion of it.
Imagine that you have a £100,000 mortgage with a 3.5% interest rate, which suddenly doubles to 7.0%. The most your payments will increase by on a capital repayment basis (assuming that you are right at the beginning of a 25-year term) is just over £200 – from £501 to £707. Your interest only repayments, on the other hand, will double – from £292 per month to £584 per month. And this is just at the outset.
With a repayment buy to let mortgage, the further you are into the term, the smaller the interest aspect of your repayments is. Consequently, the further in you are, the safer you are from rising interest rates.
Buy to let investment is all about numbers, but there’s more to consider. Are you happy with a one-property nest-egg, or do you want to build a buy to let portfolio? Will your monthly cash flow comfortably account for emergencies such as repairs or arrears, or are your margins pretty thin?
The interest tax relief offset is decreasing in 2017
One of the main factors in the favour of interest-only is the tax saving it affords landlords. You can offset the interest portion of your buy to let mortgage repayments against your rental income when calculating tax – so obviously, the larger the interest aspect of your mortgage bill, the less tax you pay. Smaller monthly repayments? A smaller tax bill at the end of the year? To quote everyone’s favourite entrepreneur: “Cushty!”
Now, there aren’t many circumstances where the tax savings of an interest-only mortgage outweigh the interest savings of a buy to let repayment mortgage. Observe:
Scenario one: interest-only
- Loan size – £100,000
- Interest rate – 3.5%
- Payments – £291.67 per month; £3,500 per year; £87,500 over 25 years
Total maximum tax savings over 25 years: £17,500 (lower rate); £35,000 (higher rate); £39,375 (additional rate)
Scenario two: capital repayment
- Loan size – £100,000
- Interest rate – 3.5%
- Payments – £500.62 per month; £6,007.44 per year, £150,186 over 25 years (£50,186 of which is interest)
Total maximum tax savings over 25 years: £10,037.20 (lower rate); £20,074.40 (higher rate); £22,583.70 (additional rate).
See how the tax savings and interest savings measure up
As you can see, the tax savings do not outweigh the interest savings, and this is to say nothing of interest rate changes, equity releases, capital appreciation or depreciation, etc. On paper, in the long-term, repayment mortgages are definitely the better option.
Will your buy-to-let investment be long or short term?
But not every investment is a long-term one, and not all landlords want to tie up their cash in equity. Hopefully this article put some of the more common arguments against buy to let repayment mortgages in perspective, but every situation is different and the best way forward for you will depend on your circumstances.
If you wish to find out more about switching to a buy to let repayment mortgage, call our advisers for free on the number above or visit our buy to let remortgage page.