But what unfolds when you exclusively cover the interest, leaving the borrowed sum untouched? It might sound unconventional, and in many ways, it is. Opting for an interest-only mortgage doesn’t yield significant advantages when acquiring a residential property. Nevertheless, the scenario shifts when it comes to the realm of buy-to-let. Within this domain, interest-only buy-to-let mortgages can prove advantageous.
So, should you consider obtaining one? In this guide, we’ve compiled insights into why buy-to-let mortgages commonly adopt the interest-only approach and how it can potentially impact you as a landlord.
What is an interest only mortgage?
In an interest-only mortgage, your monthly payment covers only the interest on your borrowed amount. The full repayment is due at the end of the mortgage term, contrasting with a repayment mortgage where you steadily reduce both interest and the loan balance each month until it’s entirely paid off by the term’s end.
Why would anyone want an interest only mortgage?
Interest-only mortgages might not suit everyone, but they can be considered if you have a well-defined strategy to accumulate sufficient funds for the eventual repayment. This could involve a relatively secure investment approach, an assured future income source, or an expected windfall. However, it’s crucial to have a full awareness of the associated risks.
How do interest-only mortgage loans work?
Throughout the mortgage term, typically ranging from a few years to over 20 years, you’ll make monthly interest payments. However, once the mortgage term concludes, your outstanding loan amount remains the same as the initial borrowing. Consequently, you must either repay the loan in full or refinance your property. Lenders often require proof of your capacity to settle the entire balance at the term’s end, known as a ‘repayment vehicle.’ This can take various forms, such as investments, endowment policies, or ISAs.
What are the pros and cons of interest-only mortgages?
Benefits of interest-only mortgages:
For some, the appeal lies in the flexibility of commencing with lower initial payments and gradually increasing them as income or savings grow towards the mortgage term’s conclusion.
- Monthly payments are notably reduced compared to a repayment mortgage, limited to covering loan interest.
- Should your investments perform well, the possibility arises for swifter loan repayment without necessitating property sale or refinancing. If you anticipate having ample funds to cover a property’s full cost without delay, a repayment mortgage might not align with your circumstances.
- However, if this capital won’t materialize for several years, an interest-only mortgage presents an avenue to purchase property now while facilitating the full payment upon mortgage term completion.
Disadvantages of interest-only mortgages:
The primary drawback lies in the weight of responsibility associated with ensuring full repayment at the conclusion of the interest-only mortgage term.
- Typically, you’ll incur higher total interest costs compared to a repayment mortgage since the interest-bearing amount remains constant throughout the term.
- Your monthly payments exclusively cover interest, leaving the full principal outstanding at the term’s end.
- Maintenance of your repayment vehicle is an added obligation alongside the mortgage.
- If your repayment vehicle hinges on investments, pension provisions, an inheritance, or property value escalation, there’s a risk it won’t generate sufficient funds to settle your mortgage.
- Similar to repayment mortgages, early repayment of an interest-only mortgage on a fixed rate might incur early repayment charges. Review your mortgage terms for specific details on this matter.
But how do I pay back the mortgage?
Investing in assets like real estate or even cryptocurrency aims for value appreciation over time. Buy-to-let, a form of property investment, usually involves a long-term perspective, historically tied to property value growth. While nothing is guaranteed, the saying “safe as houses” reflects the relative stability of property markets.
Interest-only buy-to-let mortgages raise questions about repayment strategies. Most landlords plan to settle it through property sale, although other investments can also be considered. Often, the property’s value has risen significantly by the loan’s end, allowing you to clear the mortgage and pocket the profit (while considering capital gains tax). Alternatively, you might extend the mortgage or cash in on other assets to cover it if selling isn’t in your plans.
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