Savvy property investors who are comfortable with lending as part of their investment strategy tend to be huge advocates of interest only mortgages.
There are several reasons why an interest only mortgage vs a capital repayment mortgage when buying an investment property is recommended, but is this the best option for you?
Interest only or repayment?
Repayment mortgages are simple and easy to understand – you commit to pay monthly repayments that pay the interest and chip away at the capital you’ve borrowed in manageable chunks over the term of your loan. This results in you owning the property at the end of your term. Simple.
Interest only, you’re only really paying the interest on the capital – effectively “renting” the capital (not the property) used to purchase the asset. The “rent” concept comes from the payment of interest only to your lender. At the end of the mortgage term, you’ll still owe the full amount of money you borrowed originally (unless you make lump sum repayments during the term of your mortgage).
Repayment plans
There are several plans you can have in place to repay the amount due on your interest only mortgage to ensure you qualify. To qualify, you’ll need a credible repayment plan.
This could be:
- savings
- an endowment policy
- pension pay-out
- cash
- other investments
- sale of property at the end of the mortgage term
It’s also worth noting that some lenders still require you to be able to show a repayment plan, whether you want to retain ownership of the property at the end of your interest only mortgage or not.
Most of the time, deals available to investors will often consider rental income and the ultimate property sale as a credible strategy.
There are risks involved – the main one being the possibility that you can’t make enough from the sale at the end of the mortgage term to clear the monies owed due to a drop in the value of the property.
Why interest only is best for investors…
Interest only mortgages are best suited for buy to let investors for several reasons – the main ones being flexibility and cash flow.
Interest only lending offers greater flexibility in the event of:
- a property sitting vacant for a prolonged period
- unexpected repairs / maintenance
- additional drawings required
Interest only models will soften the blow of these issues arising.
Lower monthly repayments result in having more cash flow from the property to spend, save or invest. A lot of buy to let investors buy their properties as lifestyle investments and the interest only model allows for that quite comfortably.
‘Serial investors’ tend to utilise interest only mortgages to maximise cash flow. They then utilise these profits to assist in further buy to let investment.
Another reason why we recommend interest only lending to buy to let investors is that at the end of the lending term, you can sell the property to repay the mortgage and move onto your next investment – this allows you to take monthly cash flow from the property while you own it, clear the mortgage upon sale and keep any profit accrued from asset appreciation over time.
The majority of investors don’t intend to keep their buy to let properties for decades or own them outright – this isn’t often the goal.
The biggest concern would be asset depreciation – resulting in negative equity at the end of the lending term. This is highly unlikely over a 25 year period – particularly in Edinburgh and the central belt of Scotland.
The average £100k property purchased in 1990 increased to £224-500k in value by 2015 – even with considerable drops in value in 2008.
What about a repayment mortgage?
A repayment mortgage works better for some investors – particularly older investors who want to eventually have a mortgage free property they can leave for their family in a will.
Risk averse investors should consider a repayment mortgage, and if capital growth is your main objective, a repayment mortgage may be a better option.
Interest only mortgages tend to be recommended when a property is not your main residence because the associated risks are much higher – especially if you may want to move to another property at the end of your mortgage term, as you’ll have to pay off the capital and finance the move (deposits, fees etc).
If your main objective is to live off rental income, an interest only loan is the best option. It allows much more cash flow to finance your lifestyle as well as additional flexibility to maintain your investment.
In Edinburgh or across the central belt of Scotland, you should be confident that you’d make a healthy profit over time due to the current trajectory of inflation and historical property price increases.
To finish
It’s crucial that you opt for the best lending strategy that fits with your overall goals, plans, property, long-term strategy and lifestyle. Speak with experienced property investment specialists who can also provide specialist mortgage advice today.
