04 Jul Buy-To-Let: Interest-Only Vs Capital Repayment Mortgages
For new landlords, deciding which buy-to-let mortgage to opt for takes some thought.
Here, we’ll break down the major difference between interest-only and repayment models – your two major choices as a landlord.
Interest-only, as the name suggests, works by having you service the interest without paying down the capital on the loan.
This is the most popular model for landlords – and is more commonly used than in the residential space.
Effectively it keeps monthly mortgage payments lower than if you were using a repayment mortgage, which can obviously keep more money in your pocket every month.
As a result, you’re likely to have more cash available to invest further, if you’re looking to grow your property portfolio past one or two homes, or if you want to add value to your existing properties by refurbishing them.
Your monthly rental income should more than cover the cost of the mortgage interest, as that’s a prerequisite when applying for the loan in the first place.
If you suffer from a void period, or you’re dealing with a non-paying tenant, you don’t have such a big financial obligation hanging over your head.
With interest-only you’ll need to repay the capital balance once the mortgage term comes to an end in 25- or 30-years’ time, potentially a huge amount of money.
You might think interest-only therefore sounds overly risky, but it depends on your strategy.
A number of landlords plan to sell these investments down the line, taking advantage of long-term capital growth.
If house prices rise enough, you should be able to make a healthy profit at the end of the term, and that’s not to mention the rental income you’ll have received over the years.
Obviously relying on house prices can be risky, as they can rise and fall, but in the long-term they’ve got a track-record of increasing.
Interest-only actually used to be more attractive for landlords, when you could deduct all of your mortgage interest costs when paying your taxes. Nowadays you can only deduct 20% when operating as an individual.
Capital repayment mortgage
These mortgages are best suited for people who don’t want to be burdened with repaying a large lump sum at the end of their mortgage term – and potentially having to sell off their investment properties to do so.
They work by having you pay off the mortgage capital as well as the interest, so your monthly payments will be higher than if you used an interest-only mortgage.
The plus-side is you’ll ultimately pay down your loans until you own the properties outright, in which case you won’t have to deal with mortgage lenders anymore.
If you have the ambition of leaving a mortgage-free property to your beneficiaries in your will, this is the model to use.
Switching between interest-only and capital repayment
It is possible to switch between interest-only and repayment mortgages.
Whether you’re able to do it within a fixed or discounted rate period depends on your mortgage lender, though you should definitely be able to make a change when your current deal expires.
It may be that you’ve had interest-only mortgages for some years and want to start paying off the capital, or you’re a casual landlord using capital repayment mortgages that wants to become more highly leveraged to fund more purchases.
It depends on your needs, and we’d recommend you getting mortgage advice if you’re unsure which model is right for you. Contact our Hardisty Financial team now to discuss your needs.