If you’re someone who’s looking to invest in a property, you may be wondering what kind of a mortgage is better: interest-only or repayment.
And when buy-to-let properties are in discussion, these mortgage choices shift slightly. After all, different rules apply to buy-to-let mortgages, making them suited for entirely different investment goals.
And if you’ve scoured the mortgage scene at all, you may have noticed an abundance of buy-to-let mortgages being interest-only. But why are most buy-to-let mortgages interest-only?
There are several reasons for this, ranging from reduced monthly payments to short-term safety. Knowing these is important, and it can help you make the most out of your buy-to-let mortgage.
So, let’s go over all the details of an interest-only buy-to-let mortgage and learn why they are so prevalent.
Table of Contents
- Why Are Most Buy-To-Let Mortgages Interest-Only?
- Are All Buy-To-Let Mortgages Interest-Only?
- The Benefits Of Interest-Only Over Repayment
- The Disadvantages Of Interest-Only Buy-To-Let Mortgages
- Final Words
Why Are Most Buy-To-Let Mortgages Interest-Only?
Interest-only buy-to-let mortgages have the borrower pay interest on the loan. Once the mortgage term expires, the principal loan amount is then paid.
So, this ends up making the monthly mortgage costs low in comparison to repayment mortgages.
A vast majority of landowners choose to keep their buy-to-let mortgages interest only. And by doing so, they can save up more investment income and have access to surplus rental income.
Then, they can invest the surplus into maintaining the property or purchasing new ones altogether.
Once the loan term ends, landlords typically sell the property to repay the loan.
Are All Buy-To-Let Mortgages Interest-Only?
No, not all buy-to-let mortgages are interest-only. While it’s common for landlords to choose interest-only mortgages due to lower monthly payments, there is also the option to take a repayment mortgage for your rental property. The choice depends on individual financial circumstances and investment strategy.
The Benefits Of Interest-Only Over Repayment
The benefits of an interest-only mortgage depend on the landowner’s income and personal circumstances.
For instance, buy-to-let owners who have ample income may choose a repayment option instead, whereas an interest-only mortgage is only preferable if they don’t.
As a landlord, you will in most cases want to maximise your rental income while paying as little for your loan as possible.
So to further this goal, you may want to consider an interest-only loan over a repayment mortgage.
Let’s look at all the reasons why an interest-only loan is preferable over a repayment loan.
1. Reduced Monthly Payments
Monthly payments for interest-only buy-to-let mortgages are typically lower than that of repayment loans.
Since you’re only paying the interest on the mortgage monthly, you will only pay the interest that is due that month and not any of the capital.
2. No Income Requirements
Buy-to-let lenders often don’t have any minimum income requirement when mortgaging the property since the house becomes the source of income used for the affordability assessment.
So, lenders may be adamant about their monthly rental income exceeding the mortgage. Usually, the rental income must land somewhere around 125% of the mortgage monthly payment on interest only, depending on the lender.
3. Short-Term Security
It’s worth noting that rental downtimes can reduce your rental income to nought. After all, a property isn’t guaranteed to always be occupied.
So, if your property is empty and not making money, it’s important to minimise all expenses related to the property.
And since interest-only mortgages have a lower monthly payment requirement, you won’t have to allocate too much of your monthly budget towards paying the interest.
4. Long-Term Property Investment
Many Investors are looking for a long term investment, typically the housing market has always been a reliable market to achieve this with increasing house prices although this is not guaranteed. Coupling this with monthly regular rent could offer a significant long term benefit.
It’s worth remembering that plenty of this hinges on the housing market, and if the market sees a downturn, you could face losses.
Even so, buy-to-let properties are usually approached as an investment with plenty of benefits that pay off over a long time.
The Disadvantages Of Interest-Only Buy-To-Let Mortgages
1. Greater Amount Of Interest Paid Over Time
Buy-to-let mortgages result in the borrower paying more in interest than a repayment mortgage, as the level of interest remains the same. So, as you continue to make payments, your balance will not lower over time.
This isn’t the case with repayment mortgages, as the balance reduces as you pay. The same is applicable to the amount of interest as you continue to make payments.
2. May Require A Repayment Plan
With interest only after your mortgage term has ended, you will have to settle the mortgage balance. Some borrowers choose to sell the property and settle the balance using the sale value.
Because the housing market can be up and down, the price of your property may fall around the time your mortgage term ends or you are looking to sell. And if the sale value of your property is lower than its initial value, this can end in a potential loss.
As such, it’s important to have an exit strategy, or else your property could end up being repossessed if you have no suitable strategy to repay the capital.
Not only is this a massive personal loss for you, but it also affects your credit file negatively. It’s an undesirable outcome in all events.
Buy-to-let mortgages are usually made to be interest-only for the myriad of benefits that they afford the landlord.
These mortgages can also allow you to claim certain tax benefits based on how their properties and investments are arranged.
It’s worth noting that your repayment mortgage can be altered after inception to and from interest-only for your buy-to-let property if you meet the lenders criteria and vise versa.
That said, if you have a fixed-term mortgage, you may be required to pay a penalty for an early remortgage.
And once the term is over, you will have to pay the capital amount in full, so be sure to make a repayment strategy beforehand.
**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.
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