Interest-only buy to let mortgages
Borrowers always wonder if they can get an interest-only buy to let mortgage and how they could possibly structure one. They usually ask what mortgage deposit requirements they are and what the typical loan to value rates on an interest-only buy to let mortgage are?
In this brief guide, we will cover those main points and more.
What are buy to let mortgages?
Buy to let mortgages are unregulated mortgages which allow you to borrow money on a property which is primarily rented out.
What are interest-only buy to let mortgages?
Interest-only buy to let mortgages are buy to let mortgages which are interest-only.
This means that the monthly mortgage repayments are made up of only the interest portion of the mortgage and the capital will have to be repaid at the end of the interest-only buy to let mortgage term.
The buy to let mortgage lender will have to approve a repayment plan or vehicle for the interest-only buy to let mortgage.
You should be aware that of recent there is now a higher rate of stamp duty on buy to let properties and the tax reliefs which so many buy to let investors benefited from have now vanished.
Are most buy to let mortgages interest only?
Interest-only buy to let mortgages are much more common with buy to let investors who tend to buy and sell property relatively quickly. By only paying the interest portion of the mortgage the buy to let investors save a lot of money in comparison to a similar term bridge loan and this means they could benefit from an increased profit margein when they sell the property.
The sale of the property is usually their repayment vehicle.
In most cases the buy to let investor will do some renovation work to increase the value of the property before looking to sell it on.
How do interest-only buy to let mortgages work?
With interest buy to let mortgages you get a buy to let mortgage which is interest-only.
This means your monthly mortgage repayments are only the interest portion of your mortgage and do not affect the balance borrowed and outstanding which will need to be paid back at the end of the interest-only buy to let mortgage term.
In the past interest-only mortgages were linked to endowment policies which were then used upon maturity to pay off the balance on the interest-only mortgage.
Endowment policies are no longer available but interest-only mortgages are still readily available and with the right repayment plan attached to them they could be of great value to a buy to let investor.
Interest only vs capital repayment?
When compared with capital repayment buy to let mortgages the difference is obvious.
With a capital repayment buy to let mortgage the monthly mortgage repayments are usually much higher but they contain the balance which is being paid off and as this balance is paid off the amount on which interest is charged reduces and hence the total interest charge reduces gradually.
At the end of the mortgage term, you will have paid off the whole mortgage.
The benefits of an interest-only buy to let mortgages
Interest-only buy to let mortgages ensure that buy to let investors pay a lower monthly mortgage amount which allows them to gain better profit margins on their investments.
You may be able to offset the interest on your mortgage against any rental income and this could help you reduce your personal tax bill.
With the interest-only buy to let mortgage monthly repayments being so low. This means that if your tenants default on rent payments you may still be able to cover your monthly mortgage repayments on your interest-only buy to let mortgage with little effort.
The disadvantages of interest-only buy to let mortgages
The amount of capital you borrowed will remain the same throughout the interest-only buy to let mortgage term.
If your repayment vehicle underperforms you may find your property being repossessed.
If your repayment vehicle for your interest-only buy to let mortgage is the property then you leave yourself open if the house price falls.
If you keep the interest-only buy to let mortgage for a long term such as 25 years then you may end up paying more interest when compared with a similar term buy to let capital repayment mortgage.
What mortgage deposit do I need for an interest-only buy to let mortgage?
The mortgage deposit requirement for interest-only mortgages is quite high at 25% typically. This means an interest-only buy to let mortgage lender will only offer a loan to value rate of about 75%. This rate reflects the risks of buy to let mortgages and their interest-only element.
You may be able to find an interest-only buy to let mortgage lenders who may offer a higher loan to value rate and hence a smaller mortgage deposit from you but this will have to be under the right circumstances. E.g Having a property which is generating rental income that is 180%+ of the monthly mortgage repayment or a portfolio landlord with good credit.
How much can you borrow on an interest-only buy to let mortgage?
The amount you can borrow on an interest-only buy to let mortgage will differ from one mortgage lender to another but it will primarily be based on the coverage ratio which is determined using the monthly rental payments.
Some mortgage lender may require a coverage ratio of 150% and others may require slightly higher.
If the rent payments aren’t sufficient to get you the amount you need to borrow then you may be able to use your personal income in a manner known as top-slicing.
What repayment vehicles can I use for an interest-only buy to let mortgage?
Different interest-only buy to let mortgage lenders may have varying requirements on what they may consider as a feasible repayment plan or repayment vehicle for an interest-only buy to let mortgage product taken out with them,
In general, the below repayment plans or vehicles may be accepted:
Releasing equity from a different property to pay off the interest-only buy to let mortgage
Using an ISA account
Remortgaging to a standard mortgage or another interest-only mortgage
Selling the property at the end of the mortgage term if there has been an appreciation in value and equity.
Shares and stocks or other investments
If you are concerned about the repayment vehicle you have or are planning to use you can contact a buy to let mortgage broker who may be able to match you with interest-only buy to let mortgage lenders willing to accept the kind of repayment vehicle you have.
What are the eligibility requirements for an interest-only buy to let mortgage?
As Interest only buy to let mortgages find their mortgages as risky mortgages, they will usually carry out very strict mortgage affordability tests on borrowers looking to get approved for this mortgage.
To be eligible for the interest-only buy to let mortgages you will usually need to meet the below requirements:
You will usually need a mortgage deposit of around 25%, although you may be able to find specialist mortgage lenders who will accept lower than this.
You will not be accepted if you are a first-time buyer buy to let investor. You may find a handful of buy to let mortgage lenders who will consider you if you are a first-time buy to let investor.
Some mortgage lenders may insist you have a maximum amount of buy to let mortgages to be eligible. This can be from 3 to 5.
If the income coverage ratio doesn’t meet the interest-only buy to let mortgage lenders criteria you won’t get the mortgage
You will usually need a good credit score and history
Most lenders may insist that you are employed but you may be able to find lenders willing to lend to you if you are unemployed or self-employed
You will usually need a personal income of £25,000 at the very minimum
The mortgage lender will also put you through other mortgage affordability assessments to ensure you can keep up your monthly mortgage repayments if the property is vacant for a long period of time.
Can I make overpayments on an interest-only buy to let mortgage?
Yes, you can make overpayments towards your outstanding balance on an interest-only buy to let mortgage. These payments will reduce the balance which you are being charged interest on and hence reduce your monthly mortgage repayments and the balance you have to pay off at the end of the interest-only by to let mortgage term.
Can I get an interest-only buy to let mortgage with bad credit?
Getting a mortgage with bad credit may be difficult as mortgage lenders may usually want to lend to borrowers who have a good credit score and have shown a good repayment history on all their previous debts.
There are however mortgage lenders who will offer an interest-only BTLmortgage to a borrower depending on what type of bad credit was and what the circumstances were.
If it was a CCJ which was satisfied and is a certain age then some mortgage lenders may be willing to lend. Other mortgage lenders may lend if the CCJ was a maximum amount.
When looking to get a mortgage with bad credit the requirements from different mortgage lenders will differ and a bad credit mortgage broker may be able to assist you in getting an interest-only BTL mortgage.
Bad credit could include:
A debt management plan
A home reposession
Can I get an interest-only buy to let mortgage if I am self-employed?
Getting an interest-only BTL mortgage if you are self-employed is certainly possible but most mortgage lenders may want to see your accounts for 3 years at the very minimum although there may be mortgage lenders willing to offer a single person mortgage with less than 3 years worth of accounts but at least 12 months.
The documents you may need as a self -employed mortgage include:
Your company accounts if you work through a limited company
Bank statements for 3 months
You may find using the services of a mortgage broker who has experience dealing with self-employed borrowers.
Other considerations a mortgage lender may take into account when offering a single person mortgage to a self-employed are:
The Trading style: are you drawing a salary from a company or do you have a claim over a share of retained profits. These could make a significant difference in how much you may be able to borrow.
Your experience: how long have you been self-employed and what is your working history.
Can I change my interest-only mortgage to buy to let?
In some cases, a mortgage lender may allow you to switch your interest-only mortgage to a buy to let mortgage.
When changing from an interest-only mortgage you should be aware that your monthly mortgage repayments will likely rise as you are now paying down the capital as well and not just the interest.
If you are considering this you should speak to a buy to let mortgage broker who may be able to provide you with specialist advice.
What are the tax implications of a buy to let mortgage?
There have been recent changes in how buy to let landlords are taxed. Their personal income tax relief has changed.
In the past, buy to let landlords would state the income they have generated from their buy to let properties after they had deducted mortgage interest and other expenses in a bid to reduce their personal tax bill.
By April 2020 mortgage interest and expenses can no longer be deducted and will be replaced with a tax credit.
By April 2020 all rental income will be taxable, however, buy to let landlords will receive a 20% credit for mortgage interest.
Stamp Duty on BTL properties
If you have a second home then you can expect to pay the below stamp duty rates:
Properties up to £125k – 3%
£125k – £250k – 5%
£250k+ – 8%
Use a mortgage broker for your mortgage in principle
You may want to use an independent mortgage broker to help you get a mortgage on your new home.
Mortgage brokers are important as they can access mortgage products from across the whole of the market in some cases.
This could be over 11,000 mortgage products. This may have some advantages rather than going directly to a mortgage lender.
A mortgage broker will look to understand your financial circumstances and then provide recommendations on which mortgage products may be suitable for you based on your mortgage affordability.
After giving you these mortgage recommendations, most mortgage brokers will seek your consent to apply for a mortgage in principle.
This will allow you to shop for your home as more estate agents and sellers may take you seriously and it will also give you confidence that your mortgage is indeed a possibility before you make a full mortgage application.
Once you have found a home you want to buy and are satisfied with the mortgage offer for your mortgage then the mortgage broker will then look to get you a mortgage offer.
This will come with a key facts illustration document that details the features of your mortgage including how much you will pay per month.
It will also contain information on if there are any limits such as early repayment fees, or annual overpayment limits.
If you are happy with everything you can then go on to secure your mortgage with the help of a conveyancer.
Your conveyancer will manage the legal searches on the property to ensure there aren’t any issues with it.
They will oversee the sales agreement to ensure it is in your best interest, they will manage the transfer of mortgage funds, exchange contracts with the seller or their conveyancer, and set a completion date with the seller or their conveyancer.
This will then bring an end to the conveyancing process, at which point you will receive the keys to the house and move in.
If you need financial advice and you live in the UK then you could contact the Money Advice service over the phone or via chat for impartial advice.
You can also contact the debt charity “Step Change” if you are in debt and need help.