Buy To Let Interest-Only Mortgage vs Repayment Mortgage

Did you know that there are two types of buy-to-let mortgages; repayment and interest-only? They both offer different benefits and drawbacks to property investors. But which is best for you? Choosing between the two can be a difficult decision that may affect the returns on your investment. Read on to find more out about interest-only and repayment mortgages, which one is best suited to your financial situation and goals, and more.

Table of Contents

What is an Interest-Only Mortgage?
What is a Repayment Mortgage?
Pros and Cons of Interest-Only and Repayment Mortgages for Buy To Let
How to Decide between Interest-Only and Repayment Mortgages

What is an Interest-Only Mortgage?

An interest-only mortgage, often offered to buy-to-let borrowers, is a type of mortgage where you only repay the interest on the loan every month and pay off the capital sum at the end of the mortgage term. The monthly repayments are much lower than with a repayment mortgage. This is popular with buy-to-let investors as they can make a profit on the rent paid by their tenants every month, and when the property is sold, they could make a profit on the sale if the property has appreciated in value.

What is a Repayment Mortgage?

A repayment mortgage is a more common type of mortgage that is more common with residential mortgages than buy-to-let. As with a regular mortgage, you pay off both the interest and a portion of the capital sum every month. Once the mortgage term is complete, the property is fully repaid. Repayment mortgages have a higher monthly sum than interest-only mortgages, but they still allow the property owner to build up equity. The interest is also reduced over time as more and more of the principal loan is paid off.

Pros and Cons of Interest-Only and Repayment Mortgages for Buy To Let

Choosing the right type of mortgage is important, as it will affect the profitability of your buy-to-let investment, both short-term and long-term. Here are some pros and cons of both types of mortgage that you should consider before choosing between the two.

Pros of Interest-Only Buy To Let Mortgages

Interest-only mortgages are more affordable, as there is a lower monthly cost. This can offer a higher profit margin on a rental property and frees up more cash for other investments or covering expenses.
Interest-only mortgages offer greater flexibility for property investors, allowing them to better manage void periods and maintenance costs of their rental properties.
If the property appreciates, you can sell it for more than you paid at the end of the mortgage term, making a profit.
Property investors can put the monthly profits into an ISA or other investments, helping them save for the final repayment.

Cons of Interest-Only Buy To Let Mortgages

The capital sum of the loan remains unpaid at the end of the mortgage term, leaving you with a large amount of money to pay off in one go.
Even though you only pay off the interest on the mortgage every month, interest-only mortgages often come with a higher interest rate than other kinds of mortgages.
The property needs to retain its original sale value, and ideally increase in value by the end of the mortgage term. If you sell the property for less than you paid, you will need to make up the difference yourself.
The interest will remain the same throughout the mortgage term and does not decrease like other types of mortgages, as the principal loan amount stays the same.

You will need a larger deposit than other types of mortgage (often 25% or more).

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Pros of Repayment Buy To Let Mortgages

Once the mortgage term has ended, you don’t need to pay a large lump sum – all profits from the sale of this property are yours to keep.
There is a lower risk with repayment mortgages when compared to interest-only mortgages.
The amount of interest you pay on a repayment mortgage will decrease over time, as the interest reduces in line with the size of the remaining loan.
You don’t need to plan an exit strategy for the end of the mortgage term.
You can often reduce the costs by switching to a lower fixed rate or variable interest rate.

Cons of Repayment Buy To Let Mortgages

The monthly payment on a repayment mortgage is a lot higher than with an interest-only mortgage, increasing your monthly costs and limiting investment opportunities in additional properties.
Few lenders will offer buy-to-let repayment mortgages, reducing your potential funding options. You may need to use a specialist mortgage lender.
You are still required to pay this higher monthly payment, even during void periods.

FAQ: Can I have a hybrid interest-only and repayment mortgage?

It is possible to have a combination of an interest-only and repayment mortgage, in which you pay back an agreed percentage of the loan as well as the interest each month. This is hard to obtain and is only offered by specialist mortgage providers. You could also switch between the two depending on the loan amount and if your mortgage lender would allow this, or you could remortgage with a different provider.

How to Decide between Interest-Only and Repayment Mortgages

When considering which type of buy-to-let mortgage is right for you, you should think about what your investment goals are, both short-term and long-term, what your risk tolerance is, your current financial situation and cash flow needs, and other factors. Interest rates can also be an important consideration. If mortgage interest rates rise, this can have a more detrimental effect on those with interest-only mortgages than those with repayment mortgages. If you choose an interest-only mortgage, then you need to have a strategy in mind for paying off the full borrowed amount at the end of the mortgage term, whether by selling the property, using the rental profits, or money from other investments. Have a contingency plan in mind for what you will do if the property decreases in value or you have unexpected expenses that affect your rental income.

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