When choosing the right buy-to-let mortgage, landlords face a key decision: go with an interest-only deal or opt for a capital repayment arrangement.
Both options have their pros and cons. Let’s take a closer look.
Interest-only mortgage
Your payments only cover the interest on the loan and have no impact on the capital.
Pros
1) Lower repayments
Your monthly repayments are lower than that of an equivalent capital repayment mortgage.
For example, with a 25-year interest-only mortgage of £200,000, monthly repayments would be £573 (4.45%, fixed for three years). With a similar capital repayment mortgage, you’d pay £996 a month*. That’s a difference of £423 a month.
2) Less financial stress in between tenancies
If the property is vacant for any reason, it will fall on your shoulders to cover the repayments. Lower repayments equal less stress.
3) Bigger monthly income
As your mortgage repayments are lower, less of the rent goes to your lender. Instead, it winds up in your pocket.
4) More flexibility
You can spend this extra cash on the upkeep and improvement of the property or divert it to other investments.
5) Sell and make a profit
If the property appreciates in value over time, you can sell up and make a tidy profit.
Cons
1) You won’t own the property
As you won’t be repaying the capital loan, you’ll still owe a substantial sum at the end of the mortgage. (Although you can sell the property, pay this debt, and hopefully, still be ahead.)
2) The lender earns more
You pay more interest to your lender over time compared to a capital repayment mortgage. This is because you never reduce the size of the capital loan, so the interest charges never reduce.
3) Risk of negative equity
Historically, property prices have been on an upward trajectory – last year, they grew in the UK by a whopping 8.5% – so the risk of negative equity is low.
And even if prices do drop, if you’re prepared to ride out market fluctuations, then the long-term outlook is positive.
The real risk comes if you need to sell in a hurry. If the property’s value has dropped, you could end up owing more than the property is worth.
Capital repayment mortgage
Your monthly repayments cover the interest and gnaw away at the capital.
Pros
1) Ownership
At the end of the mortgage term, the property will be yours.
2) Less interest
You pay less interest overall because the capital loan decreases – albeit gradually – with every repayment.
Cons
1) Higher repayments
As we mentioned earlier, the monthly repayments will be higher, and you’ll need to cover them when the property is vacant.
Choosing the right option
There’s no one-size-fits-all solution, although most landlords opt for interest-only**.
Landlords need to weigh up their circumstances and investment goals carefully. For some, the priority is earning a monthly income; for others, it’s working towards owning a property that they can pass on to their children or even move into themselves.
For advice about making a buy-to-let investment work for you, contact us here at NAME.
*Approximate figures only, based on a property worth £265,000. Always seek independent financial advice.
** National Landlords Association