Repayment or Interest Only Buy to Let Mortgage?
Property has long been considered a great retirement vehicle either alongside or in place of a pension but if you’re interested in buying a rental investment to see you through your old age but which should you choose, a repayment or interest only buy to let mortgage?
The main difference between the two is that with an interest only mortgage you will just pay the interest every month, meaning your repayments will be lower but you will not be paying off the mortgage so you will still owe the amount you initially borrowed at the end of the mortgage term. Whereas with a repayment mortgage your monthly payments will be higher, but the extra money will be going towards paying down the loan so at the end of the term your mortgage will be paid off in full.
But, thanks to changes in the way buy to let mortgages are stress tested, since 2017 it has proved near impossible to purchase a buy to let property using a repayment mortgage. And that’s because prior to 2017 the rent achieved needed to be 125% of the cost of servicing the loan (worked out at 5% annual interest) so a £200,000 property bought with a £140,000 loan would need rent of £730 per month to meet the stress test on an interest only mortgage and approximately £1,095 to cover a repayment mortgage which is already pretty high but certainly achievable with the right property.
Since 2017, though, despite the outlook for interest rates rising anywhere near this level being extremely remote, the interest rate lenders have been told to use is 5.5% and should you be a higher rate tax payer, which most property investors are, the rent must usually be 145% of the mortgage repayments. So, the same £200,000 property bought with a £140,000 mortgage must now achieve a rent of £930 just to cover the interest payments of an interest only mortgage and should you wish to take a repayment mortgage the rental figure you would need to achieve would be around £1,395. This could be manageable in the most favourable of circumstances but for most landlords achieving a rental yield at this level would be a distant dream.
Although there are some exceptions to the rules as a few lenders do have different criteria, it is now generally the case that most buy to let investors and landlords are forced to buy property using an interest only buy to let mortgage regardless of whether they want to or not. My advice to someone who wanted to buy an investment property with the aim of being mortgage free in 25 years’ time would be to take an interest only mortgage with a fixed rate deal and then speak to an expert in wealth management with the aim of putting an extra 50% or so of the interest paid into a savings account or other investment vehicle that you could use to pay down the mortgage each time the fixed rate period comes to an end.
This offers the best of all worlds as you are planning for your retirement but still have reasonably easy access to your savings should you need it.
If you would like to learn more about buy to let mortgages and how Blueberry Mortgages Bicester can help, please get in touch for an informal chat or to book your free mortgage consultation.