If you are considering investing in rental properties or expanding your existing portfolio, understanding the intricacies of interest-only buy-to-let mortgages is crucial.
Unlike traditional repayment mortgages, interest-only options allow borrowers to pay only the interest accrued each month, with the principal amount remaining unchanged. This unique structure can impact your cash flow and long-term investment strategy.
As such, we will delve into the world of interest-only BTL mortgages, exploring their benefits, potential risks, and eligibility criteria.
By the end of this guide, you will be equipped with valuable insights to make an informed choice regarding interest-only buy-to-let mortgages.
Table of Contents
What Are Interest-Only Buy-To-Let Mortgages?
Interest-only buy-to-let mortgages are a specific type of loan designed for property investors who wish to purchase properties to let out tenants.
But unlike traditional repayment mortgages, interest-only BTL mortgages allow borrowers to pay only the interest portion each month. The principal amount remains unchanged throughout the mortgage term.
These mortgages appeal to investors as they offer lower monthly payments compared to repayment mortgages. This can potentially improve cash flow and provide flexibility for investors to allocate funds elsewhere.
However, it is important to note that the borrower still owes the full principal amount at the end of the mortgage term.
That said, lenders often have more specific requirements for interest-only buy-to-let mortgages, like higher deposit sizes or maybe higher rental income coverage ratios, etc.
Hence, it is crucial for investors to carefully consider their financial circumstances, rental income, and long-term payment strategies beforehand.
Are All Buy To Let Mortgages Interest-Only?
No, not all BTL mortgages are interest-only. While interest-only mortgages are available for buy-to-let properties, there are also other types of mortgages that investors can choose from. The most common alternative to interest-only mortgages is a repayment mortgage.
With a repayment mortgage, the borrower makes regular monthly payments that include both the interest and a portion of the principal loan amount. Over time, the outstanding balance gradually reduces until the mortgage is fully repaid by the end of the term.
Basically, interest-only mortgages may offer lower monthly payments, allowing investors to allocate funds elsewhere. But repayment mortgages ensure that the principal is gradually paid off.
So, the choice between interest-only and repayment mortgages depends on the investor’s financial goals, cash flow preferences, and long-term strategies.
Why You Should Opt for Interest-Only Buy-To-Let Mortgages
1. No Minimum Income Requirements
Many lenders who offer BTL mortgages do not impose any specific income criteria. This is primarily because the rental income generated by the investment property itself is considered as income.
Therefore, lenders require the monthly rental income to exceed the mortgage amount. The exact percentage may vary, but typically the rental income needs to be around 125-145% of the mortgage, depending on the lender.
This absence of minimum income requirements from certain lenders makes it relatively easier to purchase BTL property using an interest-only mortgage. On the other hand, with a repayment mortgage, the monthly payments are higher, resulting in less rental profit remaining.
As lenders assess rental affordability typically based on the interest only ICR coverage, this benefit is not that profound when comparing Buy To Let interest only mortgages and Buy To Let repayment mortgages.
2. Increased Rental Profits
Lowering the monthly payments also increases monthly rental profits, which proves valuable when dealing with maintenance expenses. Moreover, the surplus income can cover costs like insurance and fees for professional services.
Accumulating savings each month offers the advantage of potentially generating enough profit to acquire additional BTL properties. This is a common approach employed by landlords to expand their property portfolios and generate a substantial monthly income.
Furthermore, there is potential for capital gains on the property over the mortgage term. For example, when the mortgage term concludes, selling the property can be an option to repay the remaining mortgage balance.
3. Tax Efficiency
Interest-only mortgages for BTL properties can offer tax advantages, although the extent of these benefits depends on your finances and investments. Despite recent changes in landlord tax legislation, there are still tax advantages that can be utilised.
It is crucial to recognise that you have the potential to save money on taxes based on the structure of the property investments. If you require more detailed information in this regard, it is advisable to consult a tax specialist who can provide expert guidance.
4. Lower Monthly Payments
The most sought-after benefit of an interest-only mortgage is the significantly lower monthly payments. This is due to the fact that you only need to cover the interest portion of the mortgage, which is typically a fixed amount each month based on your mortgage product.
A common practice among landlords is to switch to a different buy-to-let mortgage after the introductory period ends. As a result, the interest-only payments remain low throughout the initial term of the mortgage, which typically ranges from two to five years.
By remortgaging a BTL property once the term expires, landlords can continue enjoying the advantage of keeping the interest rates low.
Potential Disadvantages Of Interest-Only BTL Mortgages
1. More Interest
An interest-only mortgage will entail higher interest payments compared to a repayment mortgage. This is due to the fact that the interest rate remains constant, as the outstanding balance does not decrease.
In contrast, a repayment mortgage involves regular payments towards the principal balance, resulting in a gradual reduction of the amount of interest owed over time.
2. May Have To Switch To a Repayment Plan
Upon reaching the end of your mortgage term, since you will still have an outstanding mortgage balance, it is imperative to have an exit strategy.
Many landlords opt to sell their investment properties, allowing them to benefit from potential capital gains while simultaneously repaying the mortgage balance in full.
However, this approach carries some risk, as property prices could potentially decline around the time your mortgage term concludes. And some lenders may not approve of this particular repayment plan.
Alternatively, you may consider employing another repayment strategy, such as utilising an investment fund to cover the remaining balance of your BTL mortgage.
Nonetheless, failure to repay your lender can result in the repossession of your property, adversely impacting your credit history.
3. Not Paying Towards Owning The Property
Unfortunately, at the end of the mortgage term, you will not have ownership of your investment property without a BTL mortgage charged against it as the capital balance has not reduced. This is because you are not making payments towards reducing the mortgage balance.
Certain lenders might offer the option to make capital repayments during the mortgage term, thereby reducing the outstanding balance.
However, this is contingent upon your specific lender’s policies and any potential early repayment charges stipulated in your mortgage agreement.
How To Qualify For Interest-Only Buy-To-Let Mortgage
To check your eligibility for an interest-only BTL mortgage, lenders will consider the factors given below:
- Minimum age – Most lenders require applicants to be at least 21, while others allow 25 years or above
- Income – Some lenders have no income requirements
- Credit score
- Affordability- This is based on rental income alongside an assessment of your personal circumstances
- Portfolio limit- Some lenders will restrict how many mortgages they can approve with one applicant
As such, the eligibility requirements for an interest-only BTL mortgage are generally similar to those of other types of BTL mortgages, as most lenders anticipate landlords to favour this option. However, like any borrowing criteria, there are hurdles to overcome to obtain mortgage approval.
These obstacles include demonstrating your projected rental income, assessing your personal affordability based on income and expenses, and considering your age and historical financial behaviour.
In case you have experienced credit issues, there are specialised brokers who can assist you with bad credit situations and attaining an interest only BTL mortgage.
Regarding the required deposit, it is customary for BTL mortgages to adhere to a maximum loan-to-value (LTV) ratio of 75% (in rare cases this can be higher). Therefore, you will typically need to provide a deposit of 25% of the property’s value.
Interest-Only Mortgage Rates For Buy-To-Let
In order to secure the most favourable BTL deals, it is best to aim for a deposit of approximately 40%. This is because lenders typically offer their best deals at an LTV ratio of 60%.
While a 40% deposit may not be feasible for many investors, it is generally the threshold at which the most attractive deals are available.
The majority of BTL lenders require a minimum deposit of 25% for an interest-only mortgage, although some lenders may accept as little as 15%.
It is important to note that lower deposits typically result in higher interest rates and fees, so it is crucial to consider this aspect.
Paying more than necessary can adversely affect your rental profits, so it is essential not to overlook this factor.
FAQs
1. How Much Deposit Will You Need?
The required deposit amount is contingent upon the type of property you are purchasing.
In the case of new build BTL properties, deposits of approximately 35% are typically required, as lenders perceive them as higher risk (in all reality very few BTL landlords will purchase a new build property to let). For regular properties, it is possible to secure competitive mortgage rates with a 25% deposit.
2. How Much Can You Borrow?
The borrowing amount available to you depends on the specific lender you approach, as each lender conducts its own affordability assessment.
Certain lenders consider your personal income as a basis for determining your borrowing capacity. On the other hand, some lenders consider the potential rental income from the property you intend to purchase.
3. Why Are Buy To Let Mortgages Interest Only?
Buy-to-let mortgages are often interest-only to keep monthly repayments lower, as the expectation is that the loan will be repaid through the sale of the property or switching to a repayment mortgage in the future. This also maximises potential rental income for the landlord.
**A buy to let mortgage will be secured against your property.
Some types of buy to let mortgages are not regulated by the Financial Conduct Authority.
All content is written by qualified mortgage advisors to provide current, reliable and accurate mortgage information. The information on this website is not specific for each individual reader and therefore does not constitute financial advice.
I am CeMAP & CERER qualified mortgage adviser and have helped a number of clients realise their dreams when they thought it would not be possible. I’m skilled at getting mortgages sorted for people with a history of missed payments, CCJs, defaults, debt management programmes, IVAs and bankruptcies.
I am CeMAP (Certificate in Mortgage Advice and Practice) qualified mortgage adviser with a strong background in Finance. I specialise in providing expert advice on a range of mortgage products, including first-time buyers, remortgages, buy-to-let mortgages and bad credit mortgages.
