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Interest Only Buy To Let

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By Pete Mugleston   Mortgage Advisor

Last updated: 25th September 2018

In this article, we will talk about how an interest only buy to let mortgage can easily be agreed and whether a buy to let mortgage needs to be interest only.  Also how you can obtain the best interest only buy to let deal to suit your circumstances and finally we will discuss some of the other factors that will need to be considered.

We will cover a range of topics including:

Introduction

The interest only buy to let market has undergone some significant changes over the past few years, with the introduction of a higher rate of stamp duty payable for buy to let and second home purchases and, more recently, the withdrawal of the tax relief on mortgage interest that landlords were benefiting from.

However the above changes have led to many landlords starting their own Ltd companies to enable them to build up a rental portfolio.  This coupled with low savings rates, has led to the buy to let interest only market steadily rising in popularity.

The emergence of popular TV shows demonstrating how money can be made from turning an unloved wreck of a property into a perfect house to rent out or sell on at a profit has also helped fuel the buy to let interest only market.

In recent times buy to let and interest only mortgages have received their fair share of negative press and it is often perceived by potential landlords that obtaining a buy to let mortgage on an interest only or a buy to let mortgage on a repayment basis is impossible.  This is a myth which we at Online Mortgage Advisor are happy to bust; the team of experts we work with have access to a variety of brokers and will strive to find you the best mortgage available.

What is an interest only buy to let mortgage?

Interest only mortgages and buy to let mortgages are two separate entities so it is appropriate and useful to have them individually defined, as you will find below. In short, a buy to let is the mortgage for a property you rent out, and interest only is the repayment type on which the buy to let is arranged.

Interest Only

An interest only mortgage is the cheapest form of borrowing and often attractive to buy to let investors.  The reason for this is that each month you are only covering the interest the debt is incurring, therefore the amount you owe remains the same and does not decrease as a repayment mortgage would.

Interest only mortgages were historically used alongside endowment policies, with the view of cashing in these policies at the end of a specified term and repaying the outstanding capital owed.  These policies are no longer widely available, however interest only mortgages are and with the right repayment method in place they can be very profitable, especially for buy to let investors wanting a monthly income without repaying the mortgage.

The advantages of an interest only mortgage are:

  • The monthly mortgage commitment is lower
  • The lower payment each month can be viewed as a safety cushion for times when the property isn’t let
  • Positive tax implications as you can offset interest paid on the mortgage against the rental income (The 2018-19 tax year allows only 50% tax relief, the year after it will be 25%) this could result in reducing your personal income tax bill.  It is important to note that these rules are changing and we will discuss these in more detail later in the article.

There are however a few a disadvantages of an interest only mortgage:

  • Most importantly, you must remember that the amount of capital you originally borrowed will not decrease
  • If you are using the sale of this property to repay the debt you may leave yourself exposed to the volatile housing market.  This can cause problems if you have to sell the property for less than its original value.
  • If left to run its full term you could end up repaying back more interest in total when compared to a repayment mortgage, where interest is usually recalculated on a constantly reducing balance.

Buy to let repayment v interest only

There are pros and cons to both mortgage types. Some people ask us if are buy to let mortgages interest only. The answer is not necessarily – you have the option of choosing interest only or repayment mortgage for a buy to let.

The repayment mortgage means that that the debt is cleared after the agreed period, typically 25 years. An interest only mortgage means you’ll still have the capital to pay at the end of the loan period.

The advantage of an interest only mortgage is that the monthly repayments are lower.

Buy to let mortgage - interest only v repayment cost comparison

If you had a mortgage for £160,000 with an interest rate of 4%, the costs would work out as follows:

Total Cost

Interest Paid Interest Paid

Repayments

Repayment

£252,316 £92,316

£841.05

Interest Only £326,175 £166,175

£553.92

So the repayment mortgage works out cheaper overall, but has a significantly higher monthly repayment.

As far as a buy to let property is concerned, there may be good reasons to opt for the interest only route. Talk to one of the advisors we work with for the best advice on which option suits your circumstances.

Buy to let interest only strategy

If you opt for the BTL interest only option, then you’ll need a strategy to pay the capital when it comes due.

These could include:

  • Selling the property at the end of the loan period (Hoping there is enough equity to cover the mortgage)
  • An ISA into which you make regular payments to cover the capital
  • Shares and stocks (Risky, as they may not perform well enough to pay the mortgage out in full)
  • Remortgaging into a standard or another interest only loan.

Buy to let mortgage

A buy to let mortgage sometimes referred to as BTL, is a mortgage which enables you to purchase a property with the aim of renting it out.  There are some restrictions of the property if a buy to let mortgage is taken out, for example some lenders may not allow the property to be rented out to relatives.  However the experts we work with at Online Mortgage Advisor will guide you through these and advise if they are applicable to your purchase.

Eligibility for an interest only buy to let mortgage

Interest only buy to let mortgages can be seen by lenders as a higher risk than a traditional residential mortgage, therefore the eligibility for these mortgages can be more stringent.  This is an area the team of experts we work with at Online Mortgage Advisor can offer reassurance and knowledge in, due to the vast amount of experience in interest only buy to let mortgages they have.

There are some restrictions that are common amongst most lenders that need to be factored in however, these are:

  • Interest only buy to let mortgages are not usually offered to first time buyers.  There are just a handful of lenders who will consider first time buyer landlords, who have not ever owned a property and where their first purchase is for renting out.
  • Some lenders will limit the amount of buy to let mortgages held across their group of lenders from 3 to a maximum of 5, which can hinder portfolio building (although there are portfolio specialists).
  • There is often a minimum age restriction of 21, however some will consider applicants at 18.
  • A significant deposit, often 25% is needed (although some lenders can consider a minimum of 15%).  This will be discussed in further detail.
  • Applications are subject to Income Coverage Ratio testing to ensure the application is viable, this will be discussed shortly also.

Whilst the above points are specific to a buy to let interest only mortgage, there are a number of factors that will also impact your choice of mortgage, and which lender may approve you, including:

  • Personal income & affordability
  • Credit history
  • Property type
  • Employment
  • Personal circumstances

The team of expert advisors available at Online Mortgage Advisor can professionally and efficiently guide you through all of these points, helping you obtain the right mortgage.

Buy to let interest only mortgage deals – who has the best rates?

Every lender is different, which is why we work with ‘whole of market’ mortgage advisors who have access to the best buy to let, interest only mortgages in the UK, accessing deals across all lenders.

Some of the main high street names such as Lloyds, Halifax, TSB, HSBC and Coventry Building Society offer interest only buy to let and repayment mortgages, as well as numerous specialist lenders.  Much depends on how much they are prepared to pay in regards to LTV (loan to value) – some will entertain an 80 or 85% LTV, while a few would consider 90% LTV.

It’s also worth mentioning rate types here, as lenders have a range of products on offer to suit each borrower’s requirements, and some offer different terms if you opt for an interest only buy to let mortgage on a 5 year fixed rate.

The most important thing to remember is that the best deal in the market is only really available to a select few individuals who meet all of the lending criteria. For the masses who don’t, getting the best rate can be difficult given the sheer number of lenders and products in the market.

In order to find the best deal, it is always recommended that you make an enquiry and speak to one of the experts to get the right advice to suit you.

How much can be borrowed on an interest only buy to let

Income Coverage Ratio (ICR)

A buy to let interest only mortgage will be assessed on whether it is a viable investment based on the rental yield, i.e. the amount charged per calendar month for rent must be higher than the monthly mortgage commitment. Traditionally, lenders would require that the rental yield be 125% of the mortgage payment at a typical rate of 5%. For example:

  • £100k mortgage @ 3.5% = £292 per month
  • £100k mortgage @ 5% = £417 per month, stressed at 125% = £521 per month.  Therefore the rental charged per month must exceed £521 for this investment to be viable.

The potential rental income charged will also be confirmed once the property is valued.

However due to increasing costs to landlords in recent times, especially with the changes in interest tax relief, some lenders are increasing the amount required and introducing different income coverage ratios (ICR).

For example, assuming the same £100k mortgage is required:

  • Lender A will require a rental income of £573, which has an ICR of 5.5% stressed at 125%.
  • Lender B will require a rental income of £642, which has an ICR of 5.5% stressed at 140%.

As you can see the difference between these 2 two lenders is substantial and can be the deciding point as to whether to proceed with the mortgage or not.

The team of expert advisors we work with here at Online Mortgage Advisor are highly trained in the area of buy to let interest only mortgages and have the expertise to guide you through the process swiftly and smoothly.  They will find the right broker for your circumstances who will use their expertise to find the best buy to let interest only mortgages for you to compare.

Top Slicing – using your personal income to borrow more on a buy to let

As discussed above, a buy to let interest only application is assessed by looking at the proposed rental income, however there are some lenders that will consider using the borrower’s personal earned income if there is a shortfall in the amount needed by the borrower.

This is predominantly aimed at high income earners, but can be a useful tool if there is a shortfall in the rent and is referred to as top slicing.

If we refer back to the previous example, lender A will not allow any top slicing however lender B, whose ICR is higher will allow the use of personal income, which could mean a lower rental income could still be used, thus offering a higher maximum loan amount.

Other lenders will use an affordability assessment to create a tailored approach to each individual’s circumstances.

What deposit do you need for interest only buy to let?

Most lenders will require a substantial deposit on an interest only buy to let mortgage due to the higher risk they present. At present this is typically 25% so a 75% loan to value (LTV) is required, with a few offering an 80% LTV buy to let interest only mortgage.  These deposits of 20% are reserved for experienced landlords with a current buy to let portfolio, there are also one or two offering 15%.

The experts we work with at Online Mortgage Advisor can advise you on what deposit will be required for your buy to let interest only mortgage based upon your individual circumstances.

Tax Implications

As mentioned earlier, the buy to let interest only market has had its fair share of negative press following the recent collapse of the housing market, with some headlines blaming the increasing number of landlords for first time buyers having such a difficult time in obtaining a mortgage.  This has in turn led to some significant changes in how landlords and the interest only buy to let mortgages and properties they have are taxed.

Personal income tax relief

Historically, landlords would declare the income earned on rental properties after mortgage interest and expenses had been deducted to reduce their personal tax bill.  However in April 2017 changes were introduced and by April 2020 mortgage interest and expenses can no longer be deducted and is to be replaced with a tax credit. This change is being phased in over a 4 year period, as follows:

  • Tax year 2017/18 75% mortgage tax relief
  • Tax year 2018/19 50% mortgage tax relief
  • Tax year 2019/20 25% mortgage tax relief

By April 2020 all rental income will be taxable, however landlords will receive a 20% credit for mortgage interest.

Stamp Duty

Stamp duty is a tax paid on the purchase of a property in the UK, however recent changes have been introduced that affect buy to let properties and second homes. This means that from April 2016, the following higher stamp duty rates now apply:

  • Properties up to £125k – 3%
  • £125k - £250k – 5%
  • £250k+ - 8%

These figures are based on recent information published by HMRC and are only accurate at the time of writing. The experts we work with can advise you on any recent changes that may have occurred.

Conclusion

The aim of this article was to provide a short but concise guide to buy to let interest only mortgages explained.  It was also to answer the common question of “can I get an interest only buy to let mortgage?’ and the short answer is, yes.

Despite what your high street bank or current lender may have said, a buy to let interest only mortgage in the UK can be obtained in loads of scenarios that may not be agreed on the high street.

As you can see, not all buy to let mortgages are interest only. Some lenders will consider other types of mortgages and different lenders require different deposits.

Talk to an expert

At Online Mortgage Advisor the team of experts we work with, help first time and existing landlords take out buy to let interest only mortgages on a regular basis, their knowledge and experience will give you confidence that they will get you the best mortgage available based upon your unique circumstances.

If you like anything in this article or you’d like to know more, call Online Mortgage Advisor today on 0800 304 7880 or make an enquiry here.

Then sit back and let us do all the hard work in finding the broker with the right expertise for your circumstances.  – We don’t charge a fee and there’s absolutely no obligation or marks on your credit rating.

Updated: 25th September 2018
OnlineMortgageAdvisor 2018 ©

FCA disclaimer

The information on the site is not tailored advice to each individual reader, and as such does not constitute financial advice. All advisors working with us are fully qualified to provide mortgage advice and work only for firms who are authorised and regulated by the Financial Conduct Authority. They will offer any advice specific to you and your needs.

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