Repayment or Interest Only? Mortgages for Buy-to-Let

It goes without saying that landlords have a lot of tough choices to make; where to invest, what kind of property to invest in, and what kind of target market to approach?

These are all important questions, but just as important is how you finance your investment. That means choosing what type of mortgage is most appropriate for your buy-to-let property? We know that the main difference between a mortgage is the difference between their rates, which can amount to thousands of pounds over the lifetime of the deal.

Before you consider mortgage rate, though, you need to decide whether you want a repayment mortgage or an interest-only one. In order to help you make that decision, we’ve explored both options and listed the pros and cons of each mortgage type. So, let’s get started.

What is a Repayment Mortgage?

A repayment mortgage is exactly what it says on the tin. Alongside paying interest on the mortgage each month, you also pay off a small amount of what you borrowed.

As such, over a period of years, you add more equity to property. With a repayment mortgage, so long as you’re able to make all of your monthly payments, you are guaranteed to have repaid your whole loan by the end of the mortgage term, which is usually around the 25-year mark.

Repayment mortgages come with a variety of different interest rate options, from fixed term to variable, but the main advantage is that when you come to sell, you can release all the equity you’ve added over the years.

What is an Interest-Only Mortgage?

This mortgage is often used by landlords who have a portfolio holding more than one property but for landlords which are new the scene, this might seem a little strange.

With an interest-only mortgage, all you pay is the monthly interest on the loan, which means you don’t add equity to the property. Instead, you rely on recovering the cost of the mortgage when you come to sell.

The National Landlords Association suggests that most landlords choose an interest-only mortgage, but unlike residential buyers, don’t plan a separate repayment vehicle (your savings, investments or other assets).

This is because the rental income covers the monthly interest and since you’re not repaying the mortgage, that allows you to make more profit from the rent. A landlord will usually then go on to sell the property at some point in the future, eventually making a profit from any house price inflation as well as paying back the capital owed.

Repayment: The Pros and Cons

The Pros:

  • You’re able to be confident knowing your mortgage is going to be completely paid off at the end of the term;
  • At the time you start paying off the original mortgage, the equity (which is the mortgage value minus the mortgage balance) in that property will increase if the loan balance is paid down, or, if the property value increases. This would typically work in your favour if you wanted to change mortgage lender or buy a second property;
  • Due to the fact that it is paid off early, the total interest you’ll be paying is going to be lower than an interest-only mortgage over the entire lifetime of the loan;
  • When you come to sell, you can release all the equity you’ve built over the years.

The Cons:

  • The monthly payments you pay to the mortgage lender are going to be higher than an interest-only mortgage;
  • If you want to move house within the next few years, you will still have the majority of the loan left to pay back, as the first payments mainly cover the interest.

Interest-only: The Pros and Cons

The Pros:

  • The monthly repayments are more likely to be lower as you’re only repaying the interest as we discussed earlier, and not the capital of the loan;
  • You’re able to invest your money, as you aim to pay off the mortgage at the end of the term, and there is even the prospect of paying it off earlier if your investments perform well;

The Cons:

  • You will need to make sure you’ve got enough money available to repay the loan at the end of the mortgage;
  • You won’t be increasing the equity in your home over the mortgage period;
  • If you choose a retirement interest-only mortgage, it could mean you’d have to leave little or no inheritance.

Which One Suits You?

With flexibility, interest-only mortgage payments are going to be lower than if you’re also making repayments.

This means that you’re going to have lower overheads, which can be a big advantage if you’re hoping to grow your portfolio and finance other properties.

Lower payments are important, for the ultimate danger as an investor is the inability to pay your monthly costs. 

As an investor, if you can’t meet your outgoings, eventually the property will be repossessed by the lender, and when this happens, you’re going to lose the stream of income, as well as the money you put in as a deposit.

A lower payment will make it easier for you to make these payments, even if you have a period where the property is empty.

However, many lenders have decided to stop offering interest-only mortgages, or will only offer them to certain individuals, so your choices may be more limited than you expected.

So, for those investing to generate income, the interest-only option may be the best one for you. If it’s capital growth, and a lump sum that is needed, or you want to pass on a fully-owned asset to your family when you die, the repayment option might be better suited to you.

What’s Next?

As an investor, if you’re leaning towards the repayment option, it means you’ll almost definitely get the security of owning it outright within the 25 years. However, this might be a little too far in advance if you’re not sure about where you’ll be in the future in terms of your investments.

If you’re mostly thinking about the “right now”, then interest-only mortgages might be more your style, as your monthly payments are going to be continuously lower.

There’s a lot to weigh up, right? At Taylor Rhodes, we recommend working with a mortgage broker, and discussing your own situation with us, as we are experienced in working with investors undergoing new and ongoing projects — contact us today.