Property investment can be complex, with numerous financing options available to prospective landlords. One such option is an interest-only buy-to-let mortgage, a popular choice for many property investors. This type of mortgage allows landlords to pay only the interest on their loan each month, leaving the initial amount borrowed—the capital—to be repaid at the end of the mortgage term. This arrangement often results in lower monthly payments, providing potential advantages in terms of cash flow and financial planning. However, understanding the ins and outs of interest-only buy-to-let mortgages, from eligibility and affordability to repayment strategies, is key to making an informed investment decision. In this guide, we will delve into the complexities and considerations of these particular mortgage products, helping you decide whether an interest-only buy-to-let mortgage aligns with your property investment ambitions.
An interest-only buy to let mortgage is a type of mortgage where, for the term of the loan, you only pay the interest charged by the lender. The principal, that is the original amount borrowed, remains unchanged and must be repaid in full at the end of the mortgage term.
This type of mortgage is typically used by property investors or landlords in the buy to let market. The idea is that the monthly repayments are lower because you’re only paying the interest. The capital is repaid when the property is sold. Landlords typically rely on rising property prices to ensure that when the property is sold, it covers the initial loan and hopefully returns a profit.
However, it’s worth noting that if property prices fall, you could face a shortfall and will need to find funds from elsewhere to repay the loan. Therefore, while this can be a profitable investment strategy, it also comes with a degree of risk.
Buy-to-let mortgages are designed specifically for individuals who wish to purchase property as an investment, rather than as a place to live. Here’s a basic outline of how they work:
1. Loan Purpose: Buy-to-let mortgages are given on the basis that you will be renting the property out to tenants and earning an income from this rental. They’re not designed for properties you intend to live in yourself.
2. Loan Assessment: Lenders determine the loan amount based on the expected rental income from the property, rather than the borrower’s personal income. The rental income is usually expected to be 25-30% higher than your mortgage payment.
3. Down Payment: Buy-to-let mortgages typically require a larger down payment (deposit) than residential mortgages. The down payment can be anywhere from 20% to 40% of the property’s value.
4. Interest Rate: The interest rates on buy-to-let mortgages are often higher than those for regular residential mortgages.
5. Repayment Structure: The mortgage can be either interest-only or repayment. An interest-only mortgage means you only pay the interest each month, with the full loan amount due at the end of the mortgage term. With a repayment mortgage, you pay back a part of the loan as well as the interest each month.
6. Mortgage Term: The term of a buy-to-let mortgage typically varies between 5 to 35 years.
7. Regulations: Buy-to-let mortgages are usually regulated differently than owner-occupied mortgages. For instance, they are not usually subject to the same government schemes.
The amount you can borrow with a buy-to-let mortgage in the UK largely depends on the expected rental income from the property. Lenders typically require the rental income to be 125-145% of the mortgage payment, depending on the lender’s criteria and the investor’s tax status. This is often referred to as the ‘rental cover ratio’.
For example, if your monthly interest payment is expected to be £500, the lender will want to see a rental income of, typically, £625-£725 per month (i.e., 125-145% of the mortgage payment).
Also, most lenders require a minimum income, often around £25,000 per year, although this can vary.
Another key factor is the deposit you are able to put down. Buy-to-let mortgages usually require larger deposits than residential mortgages – typically between 20% and 40% of the property’s value. The higher the deposit, the lower the ‘loan-to-value’ (LTV), which can often secure more favourable mortgage terms.
It’s worth noting that each lender has their own specific criteria, so the exact amount you can borrow may vary. It’s also important to consider any potential changes in circumstances, such as periods when the property might be vacant (known as ‘void periods’), which could impact your ability to cover mortgage payments.
As a rule of thumb, it’s recommended to seek advice from a mortgage broker or financial advisor who is familiar with buy-to-let mortgages to ensure you find a mortgage that suits your specific circumstances.
The cost of an interest-only buy-to-let mortgage depends on a number of factors including the mortgage amount (i.e., the principal), the interest rate, the term of the mortgage, and any additional fees charged by the lender.
Mortgage Amount: The amount you borrow is the principal. The more money you borrow, the higher your interest payments will be.
Interest Rate: The interest rate is what the lender charges you to borrow the money. Rates can vary widely between lenders and products, so it’s essential to compare multiple options. Also, bear in mind that buy-to-let mortgage rates are typically higher than residential rates.
Mortgage Term: This is the length of time you have to pay back the mortgage. With an interest-only mortgage, you’re only required to pay the interest each month, so the monthly payments will be lower than with a repayment mortgage. However, the total cost over the term may be higher because you’re not reducing the principal.
Lender Fees: These could include arrangement fees, valuation fees, legal costs, and potentially early repayment charges if you repay the mortgage before the end of the term. Some fees may be added to the mortgage amount, which means you’d be paying interest on them.
Let’s illustrate with an example: If you have an interest-only buy-to-let mortgage of £200,000 with an interest rate of 3% over 25 years, your monthly interest payment would be around £500 (£200,000 * 0.03 / 12). Over 25 years, the total interest you would pay would be £150,000 (£500 * 12 months * 25 years), plus the original £200,000 borrowed.
Remember, with an interest-only mortgage, you’re not paying down the principal, so you need to have a plan to repay the full loan amount at the end of the term. This might involve selling the property or arranging a different form of financing.
A mortgage broker can play a crucial role in helping you choose the right mortgage for your circumstances. Here’s how:
Expert Advice: A mortgage broker has the knowledge and expertise to guide you through the process, answering any questions you may have and offering advice tailored to your individual needs and circumstances. They can explain complex mortgage terms and conditions in a clear and understandable way.
Access to a Wide Range of Products: Brokers have access to a wide range of mortgage products from different lenders, including some products that are not available directly to the public. They can therefore help you find a mortgage deal that you might not have found on your own.
Save Time and Effort: Searching for a mortgage can be time-consuming and complex. A broker can do the hard work for you, researching and comparing different mortgage deals. They can also help speed up the application process by liaising directly with the lender on your behalf.
Bespoke Financial Solutions: Mortgage brokers can assess your financial situation and understand your long-term financial goals. They can help you select a mortgage product that aligns with these goals, whether it’s a fixed-rate mortgage, a variable-rate mortgage, an interest-only mortgage, or a repayment mortgage.
Assist with Application: They can assist you with the mortgage application process, helping you fill in the application forms and advising on the documentation that you need to provide. This can increase the chances of your application being accepted.
Post-Sale Service: Even after your mortgage is secured, your broker can provide ongoing support, such as reminding you when your initial deal is about to end so you can look for a better rate.
Interest-only buy-to-let mortgages are generally available to a wide range of individuals, but the specific eligibility criteria can vary between lenders. Here are some common eligibility requirements:
Minimum Age: Many lenders have a minimum age requirement, typically around 21 or 25 years old.
Maximum Age: There might also be a maximum age at the end of the mortgage term, often around 75 or 80. This means, for example, if the maximum age is 75 and the mortgage term is 25 years, you would generally need to be 50 or younger to apply.
Income: Some lenders require a minimum personal income, often around £25,000 per year, though this can vary.
Credit History: A clean credit history can make it easier to get a mortgage, although some lenders may be willing to consider applicants with less-than-perfect credit.
Residency Status: Many lenders require you to be a UK resident, although some may offer buy-to-let mortgages to non-residents or expats.
No, not all buy-to-let mortgages are interest-only. Interest-only mortgages are popular in the buy-to-let market because the monthly repayments are lower, allowing landlords to maximise cash flow. However, it’s crucial to have a solid plan for repaying the capital at the end of the mortgage term.
On the other hand, repayment mortgages can provide the certainty of owning the property outright at the end of the mortgage term, but they come with higher monthly repayments.
Yes, non-residents can apply for interest-only buy-to-let mortgages in the UK, but the process can be more complex and the choice of lenders may be more limited.
Not all UK mortgage lenders will offer buy-to-let mortgages to non-residents. However, there are specialist lenders and international banks that do provide these services.
There may be additional legal considerations, such as the potential need for Power of Attorney if you’re unable to attend the mortgage closing in person.
It’s also important to understand the tax implications both in the UK and in your country of residence. Non-resident borrowers might be required to put down a larger deposit, sometimes as much as 40% or more. Some lenders may require non-residents to have a UK bank account.
Yes, you can sell your mortgaged property to repay an interest-only mortgage. In fact, this is a common strategy used by many investors in the buy-to-let market.
With an interest-only mortgage, you only pay the interest on the loan each month, and the original loan amount (the capital) is not reduced. This means that at the end of the mortgage term, you owe the lender the full amount that you originally borrowed.
One way to repay this capital is by selling the property. If property prices have risen over the term of your mortgage, the sale price may cover the capital and potentially provide a profit. However, this strategy is not without risk. If property prices fall, you may not get enough from the sale to cover the loan, and you’ll need to find the remaining funds from elsewhere.
It’s important to note that any plan to repay an interest-only mortgage using the sale of the property must be agreed upon with the lender at the outset. You should also regularly review this plan to ensure it’s still viable, considering factors like property market conditions and changes in your financial situation.
Interest-only mortgages are often preferred over repayment mortgages in the buy-to-let sector for a few reasons:
Lower Monthly Payments: With an interest-only mortgage, you’re only paying the interest on the loan each month, not the capital. This makes the monthly payments lower than they would be with a repayment mortgage, which can make it more affordable in the short term and improve cash flow.
Maximising Rental Yield: The lower monthly payments can help landlords to maximise their rental yield (the return on investment). This is because the difference between the rental income and the mortgage payment can be greater with an interest-only mortgage.
Potential Capital Growth: Landlords often rely on the potential capital growth of the property to repay the loan at the end of the term. If the property market grows over time, the property may be sold for more than the initial purchase price, allowing the landlord to repay the loan and potentially make a profit.
Tax Efficiency: Prior to the changes in tax relief for landlords in the UK (phased in from April 2017 to April 2020), interest-only mortgages could be more tax-efficient. This is because the interest part of a buy-to-let mortgage used to be fully tax-deductible. Although the tax situation has changed and this benefit has been scaled back, interest-only mortgages can still offer tax advantages in some circumstances.
It’s important to note that while interest-only mortgages can offer benefits, they also come with risks. The most significant risk is that you must have a solid plan to repay the capital at the end of the mortgage term. If your plan relies on selling the property, you’re taking a risk on property prices being high enough at the end of the term.
Getting the best deal on an interest-only buy-to-let mortgage can involve a combination of research, preparation, and professional advice. Here are some steps you can take:
Research the Market: Start by researching the current market trends, such as average interest rates for buy-to-let mortgages, and familiarise yourself with the terms and conditions of various mortgage products.
Compare Deals: There are numerous lenders who provide buy-to-let mortgages, each with their own interest rates, terms and conditions. Compare multiple lenders to find a mortgage deal that suits your needs.
Improve Your Credit Score: A higher credit score can increase your chances of securing a better mortgage deal. This is because lenders view applicants with good credit scores as less risky. Ways to improve your credit score include paying all bills and debts on time, not using too much of your available credit, and fixing any mistakes on your credit report.
Get Professional Advice: Consider hiring a mortgage broker who specialises in buy-to-let mortgages. They can help you navigate the market, understand complex terms, and potentially get access to exclusive deals that are not available to the general public.
Larger Deposit: The more you can put down as a deposit, the lower your loan-to-value (LTV) ratio will be. This can make you less risky to lenders and could help you secure a better interest rate.
Rentability of the Property: If the property you’re buying has strong rental income potential, lenders may offer more favourable terms. They may look at factors like the property’s location, condition, and size, as well as local rental market conditions.
Check Fees: The interest rate isn’t the only factor that determines the cost of a mortgage. Be sure to check for any additional fees, such as arrangement fees or valuation fees, which can add to the overall cost.
Remember, what’s considered the “best” deal can vary depending on your personal situation and goals. Be sure to take into account not just the interest rate, but also the terms and conditions of the mortgage, to ensure it aligns with your investment strategy.
At the end of an interest-only mortgage term, the full amount that you originally borrowed (the capital) becomes due for repayment. This is because, throughout the term of the mortgage, you’ve been only paying off the interest, not the capital.
Here are some of the most common ways to repay the capital at the end of an interest-only mortgage term:
Sale of Property: You can sell the property and use the proceeds to pay off the mortgage. This strategy assumes that the property will appreciate in value over the term of the mortgage, allowing you to repay the loan and potentially make a profit. However, it is subject to property market risks.
Savings or Investments: If you have substantial savings or investments, you can use these funds to repay the loan. Some people might set up a specific savings or investment plan with the aim of accumulating enough to repay the capital.
Re-mortgaging: If you’re unable to repay the capital, you might be able to re-mortgage the property, effectively extending the term of the loan. However, this will depend on your circumstances at the time, including your age, income, and the property’s value. Also, bear in mind that this could lead to increased overall costs.
Switching to a Repayment Mortgage: If you have sufficient income and wish to keep the property, you could potentially switch to a repayment mortgage during the term of your interest-only mortgage. This would allow you to start paying off the capital, reducing the amount you’ll need to repay at the end of the term.
Property Downsizing: If you’re living in the property and are willing to move, you could sell the property, repay the mortgage, and buy a cheaper property with the remaining funds.
Interest-only buy-to-let mortgages come with a number of potential advantages:
Lower Monthly Payments: Since you’re only paying off the interest each month and not the capital, your monthly mortgage payments will be lower than they would be with a repayment mortgage. This can improve your monthly cash flow.
Higher Rental Yields: Because your monthly mortgage payments are lower, the difference between your rental income and your mortgage cost can be larger, which can increase your rental yield (the return on your investment).
Flexibility: The lower monthly payments can provide flexibility in terms of managing your finances. If you have additional funds available, you can choose to invest in further properties, make improvements to your current property, or save for the capital repayment at the end of the mortgage term.
Tax Efficiency: The mortgage interest is a deductible expense for tax purposes, which means it can be offset against rental income when calculating your taxable profit. Please note, the way mortgage interest is treated for tax purposes in the UK has changed since 2017, and by the tax year 2020-21, landlords can only claim a basic rate tax reduction on their property finance costs.
Potential for Capital Growth: If property prices rise over time, you could sell the property for a profit at the end of the mortgage term, after repaying the original loan amount. This potential for capital growth is one of the main attractions of buy-to-let property investment.
It’s worth noting, however, that interest-only mortgages also come with risks. The most significant risk is that you need to repay the capital at the end of the term, so it’s crucial to have a solid plan in place for how you’ll do this. If your plan relies on selling the property, you’re taking a risk on property prices being high enough at the end of the term.
Do I need an investment vehicle in place to have an interest-only buy to let mortgage?
No, it’s not necessary to have an investment vehicle in place to get an interest-only buy-to-let mortgage. However, you do need a credible plan for repaying the capital (the original loan amount) at the end of the mortgage term.
Here are some common ways you can plan to repay the capital:
Sale of the Property: This is a common strategy in buy-to-let, where you plan to sell the property at the end of the mortgage term and use the proceeds to repay the loan. This strategy assumes that the property will at least maintain its value, if not increase.
Savings or Investment: Some people might use other savings or investments to repay the loan. This could include cash savings, stocks and shares, or other property sales. If you choose this method, it’s essential to regularly review your savings or investments to ensure they’re on track to cover the capital repayment.
Re-mortgage: Some landlords plan to re-mortgage the property at the end of the term, essentially getting a new loan to repay the old one. This will depend on a number of factors, including your age, the property’s value at the end of the term, and your financial situation.
In the context of a residential interest-only mortgage, lenders often require an approved investment vehicle like an endowment policy, Individual Savings Account (ISA), or pension to ensure the capital can be repaid. But for buy-to-let mortgages, the strategy is often different because they’re considered a form of business loan, and the property itself (through its potential to generate income and increase in value) is seen as the primary means to repay the capital.
Regardless of the method you choose, your lender will want to see that you have a plausible plan to repay the capital at the end of the term. And remember, failing to repay the capital at the end of an interest-only mortgage term could result in the loss of the property. It’s always wise to seek financial advice when planning for a mortgage.
Eligibility for an interest-only buy-to-let mortgage can vary between lenders, but typically, lenders will assess the following criteria:
Age: There may be a minimum and maximum age limit for borrowers. The maximum age is usually calculated at the end of the mortgage term rather than at the start. This could be 70-85 years old depending on the lender.
Income: Some lenders require a minimum personal income (outside of rental income) to ensure that you can cover mortgage repayments if there’s a gap in tenancy. This can vary, but it’s often around £25,000 per year.
Rental Income: Most lenders require the rental income to be 125-145% of the mortgage payment, to ensure that you can cover the mortgage costs and any unexpected expenses. This is known as the Interest Coverage Ratio (ICR).
Deposit: Buy-to-let mortgages typically require a larger deposit than residential mortgages. You’ll usually need at least a 25% deposit, although the best rates are often available to those with a 40% deposit or more.
Number of Properties: Some lenders have restrictions on the number of buy-to-let properties you can own or the total amount you can borrow for buy-to-let.
Repayment Strategy: You must have a credible plan in place for repaying the capital at the end of the term. This might involve selling the property, using savings or other investments, or re-mortgaging.
Credit History: As with any type of mortgage, a good credit history will improve your chances of getting accepted and securing a better interest rate.
The rates offered by lenders can vary widely and are influenced by several factors, such as the size of your deposit, your credit history, and the overall market conditions.
Interest rates for buy-to-let mortgages typically ranged from around 1.5% to 5%, depending on these factors. Keep in mind, the best rates are typically reserved for borrowers with a large deposit (usually at least 40%) and a strong credit history.
Interest rates can change frequently in response to the wider economic environment and the Bank of England base rate, among other factors. It’s also worth noting that the actual rate you’re offered can depend on your personal circumstances and the specific property.
The deposit requirement for a buy-to-let mortgage, including interest-only buy-to-let mortgages, is usually higher than for a standard residential mortgage. While it can vary based on the specific lender and your personal circumstances, here’s a general guideline:
Lenders typically require a minimum deposit of 25% of the property’s value for a buy-to-let mortgage. However, to access more competitive interest rates, you might need to provide a larger deposit, often around 40% or more.
So, for example, if you were buying a property worth £200,000, you would need a minimum deposit of £50,000 for a 75% loan-to-value (LTV) mortgage, but you might choose to put down a deposit of £80,000 (40%) to get a better rate.
The exact amount can vary depending on factors such as your credit score, your income (both personal and expected rental), the property itself, and the lender’s specific criteria.
Therefore, it’s a good idea to talk to a mortgage advisor or broker, who can help you understand how much deposit you’re likely to need based on your individual circumstances and goals.
Yes, it is generally possible to switch from an interest-only mortgage to a repayment mortgage, but the specifics will depend on your lender’s policies and your personal circumstances.
Switching to a repayment mortgage means that you will start to pay back both the interest and the capital (the amount you originally borrowed) each month. This can give you the peace of mind that the mortgage will be fully paid off by the end of the term, assuming all repayments are made on time.
Higher Monthly Payments: Your monthly payments will increase when you switch to a repayment mortgage, as you’ll be paying off the loan as well as the interest. You’ll need to ensure you can afford these higher payments.
Lender’s Agreement: You’ll need to contact your lender and they’ll have to agree to the switch. They might require evidence that you can afford the higher repayments.
Remortgaging: Depending on your circumstances and the mortgage market, it might be a good opportunity to remortgage. This means switching to a new mortgage deal, either with your current lender or a new one. This could potentially give you a better interest rate, but it’s essential to factor in any fees and charges associated with remortgaging.
Loan Term: When switching to a repayment mortgage, consider your loan term. A longer term will mean lower monthly payments, but you’ll pay more interest overall.
It is possible for a first-time buyer to get a buy-to-let mortgage in the UK, including an interest-only buy-to-let mortgage. However, there are additional challenges and considerations to be aware of.
Here are a few key points:
Lender Restrictions: Not all lenders offer buy-to-let mortgages to first-time buyers. This is due to the additional risk perceived by lenders, as first-time buyers have no proven track record of managing a mortgage or being a landlord.
Higher Deposit: First-time buyers are often required to put down a higher deposit for a buy-to-let mortgage, which can range from 25% to 40% of the property’s value.
Affordability Assessment: Even though it’s a buy-to-let mortgage, lenders may still want to assess your personal income and outgoings to make sure you could afford the mortgage payments during void periods when the property may not be rented.
Experience: Some lenders may require first-time landlords to have some experience in property, even if they’ve never owned a home before. This could include experience in property management or being a renter yourself.
Stamp Duty Land Tax (SDLT): As a first-time buyer, you typically get a relief on stamp duty for properties up to a certain value when buying your first residential property to live in. However, for buy-to-let properties, you have to pay an additional 3% on top of the standard rates, and first-time buyer relief does not apply.
Yes, it is generally possible to switch a buy-to-let mortgage from a repayment to an interest-only basis. However, this will depend on your individual circumstances and your lender’s policies.
Here are a few things to consider:
Lender’s Agreement: You will need to get agreement from your lender to make the switch. They will assess factors such as your income, the rental income from the property, the loan-to-value (LTV) ratio of the mortgage, and your overall financial situation.
Affordability Checks: Even though your monthly payments may reduce by switching to an interest-only mortgage (as you will no longer be repaying the principal), the lender will still conduct an affordability assessment. This is to ensure that you can afford to continue making the interest payments and have a credible plan for repaying the capital at the end of the term.
Repayment Strategy: You will need a plan to repay the loan at the end of the mortgage term. This could involve selling the property, using other savings or investments, or re-mortgaging.
Potential Costs: There may be costs associated with switching mortgage types, such as arrangement fees or valuation fees. It’s important to understand these costs before deciding to switch.
Choosing an interest-only buy-to-let mortgage is a significant decision and involves careful consideration of several factors:
Repayment Plan: With an interest-only mortgage, only the interest on the loan is paid monthly, and the initial borrowed amount (capital) must be repaid at the end of the mortgage term. You must have a clear and reliable plan for repaying this capital. This could be through selling the property, other investments or savings, or possibly remortgaging.
Affordability: While interest-only mortgages typically offer lower monthly payments compared to repayment mortgages, landlords need to ensure they can comfortably afford these payments, even in periods without rental income (e.g., vacancies or non-payment of rent).
Rental Income: Lenders will typically want the rental income to cover 125%-145% of your mortgage payment. Make sure the property can generate sufficient rental income to meet this requirement.
Property Value Risk: If your repayment strategy involves selling the property, consider the risk that the property might decrease in value, leaving you with insufficient funds to repay the loan at the end of the term.
Interest Rate Risk: Interest rates can change over time. If rates rise, your monthly payments will increase even though the loan amount remains the same. Consider whether you could still afford the payments if this happens.
Term Length: The length of your mortgage term can affect both your monthly payments and your total cost over the life of the loan. A longer term means lower monthly payments but more interest paid overall.
Costs and Fees: Be aware of all associated costs and fees, including arrangement fees, valuation fees, and any penalties for early repayment or overpayments.
Regulations and Legal Responsibilities: Being a landlord comes with legal responsibilities. Make sure you understand these and are prepared for the work involved in managing a rental property.