Like all blog posts, this is just my thoughts, philosophy and opinion. It is not financial advice. It is also long as there is lots to consider and lots of different strategies and angles.
Most investors use interest only mortgages because everybody else is – without really understanding the implications or why they are doing it.
Before even looking at BTL, let’s look at your own home….
Thought 1
Jack and Jill are identical in almost every way. They bought houses next door to each other and paid the same £100k and took out he same £80k mortgage. They work for the same company and earn the same. They eat the same breakfast, go to the same shops and so on.
The only difference is Jack has an interest and capital repayment mortgage on his home. Jill does not – she has interest only – but pays the same amount as Jack each month. The difference between her actual mortgage cost and the payment she actually makes (to equal Jack’s) goes into a liquid savings/investment account.
Sadly, the company they both worked for went bust one day and they lost their jobs.
Jack had paid down his mortgage to £65k at the time of being of being made redundant and the property had gone up to £130k in value. He was very focused on trying to pay it off quickly and he feels like a rock star! He has at 50% LTV. Despite being made redundant, the bank still wanted their regular interest and capital repayment each month. He was unable to tap into the equity because the bank lends him money on the strength of his earnings – the property is merely a security. Without earnings, it was a short conversation with the bank! With this financial pressure’s mounting and no savings, Jack took the first crappy job that came his way and ended up with some missed payments and penalty letters from the bank for these late payment. These will stick around on his credit report for the next 6 years!
Jill on the other hand also had a property worth the same amount – £130k. Her mortgage was still £80k. Like jack she is unable to remortgage without a job or income. She does however have £15k in savings (the same as the amount Jack had reduced his mortgage by). The bank also only wanted the regular monthly interest only payment – but it is a lower amount than Jack was paying. They don’t expect or want capital. This puts her under less pressure than Jack. Yes, she eats into her savings looking for the right job and eventually finds a great new job that pays more than Jack. She has not missed payments or bad credit – just a little less in savings than she would like. With her new job she goes back to saving like she used to. With her better paying job she is able to catch up and out save Jack.
What are your thoughts?
Thought 2
Hansel and Gretel each have a BTL portfolio of 10 properties. Hansel is trying to buy the right-hand side of the street and Gretel the left. (Did you know if you own all the houses in a street you can get it renamed? They plan to call it “Candy lane”.)
All the properties are identical terraced houses all worth £100k each. Each one has a £75k mortgages on and all on mortgage products are the same with the same bank. The only difference is that Hansel is on capital repayment on all his mortgages and Gretel is on interest only on all her mortgages.
Over time Hansel has managed to pay off £5k on each of his 10 mortgages for a £50k reduction in his overall debt. Each mortgage is now sitting at £70k per property. He feels like a rock star!
Gretel also paid off £50k but she discriminated against just one property chosen at random from her portfolio as they are all alike. She has 9 properties with 75% LTV / £75k mortgages. One property has a £25k or 25% LTV balance outstanding.
A landlord with 2 properties in the street – one on the right and one on the left – calls up the twins as he is looking to sell his two properties at £100k each. They just need to come up with £25k each for the deposit and their quest to own the street gets a bit loser.
Hansel has no money and trying to raise £25k from a portfolio where the properties are worth £100k and there is a £70k mortgage is going to be very expensive. Lenders want some equity in the deal and he’ll have to refinance 5 of his properties (ignoring transaction costs which can be both slow and considerable).
Gretel on the other hand only needs to refinance one property buck up to say 75% and she is able to pull out 50k (ignoring fees again although 1x fees will be less than 5x fees). She now has the deposit for both houses and inches ahead of Hansel 12-10 in the race to buy the street.
What are your thoughts?
Thought 3
Tom & Jerry are identical twins and as fate would have it, are very similar to Hansel & Gretel in that they have 10 properties each. Jerry has his on capital and interest repayment while Tom is on interest only. Where they differ to Hansel and Gretel a bit is that they have a different lender or mortgage product on each of the properties – basically they went whole of market and looked for the best repayment or interest only deal at the time.
Jerry is repaying each loan every month just like Hansel. He is chipping away at each one and he feels like a rock star. Of his 10 loans, some will have cracking rates of interest (like 1.7%pa) and some will have adverse rates of interest (like 6.4%pa) yet all are being treated equally.
Tom looks through his list and picks the mortgage with the worst rate – the 6.4% one. The other 9 he discriminates against and cold heartedly ignores them giving all his attention to the worst one.
By always focussing on the highest rate mortgage Tom will pay off his debts faster. If he ever comes across a cracking deal, he can do what Gretel did if need be – i.e. refinance this one and hopefully on more favourable terms.
Jerry would eventually get to the same position as Tom (all debts paid off) but by treating a 1.7% loan the same as 6.4% loan it would be a much slower process.
What are your thoughts?
Thought 4
Mortgage products charge a higher rate for the higher the LTV as there is more risk. The converse is also true, the lower the LTV the cheaper the rate as there is less risk to the lender. The mortgage market changes all the time but in broad principles the rates get a whole lot nicer at 60% LTV or less.
Tom has 2 refinements to the approach he took in Thought 3 above:
A – He could focus all his efforts on the highest rate mortgage loan until the debt was paid off. It works but there is a real opportunity costs to doing this.
B – He could focus all his efforts on the highest rate mortgage loan until the LTV was just below 60%. He could then product swap or move to a new lender and benefit from the lower rate. He would then sit down and pick the next worst mortgage product and focus on getting this one down to 60% LTV before then doing another product swap/refinance.
And so it goes on and on until all debts are at 60% LTV.
What are your thoughts?
Thought 5
I, Craig Hopkins, tend to buy houses that generate around £5k-6k a year in gross income and generally have 25-year terms (although 35 years seems to be the trend with company mortgages which I like a lot!)
I always try investigate the properties history – when it last sold and what they last paid for it. I also look for surrounding properties to get an idea. Land Registry records as available on Right Move now that go back further than they used to which makes this investigation process easier.
When I go back 25 years to see what they paid for the property that I am buying (out of interest) the range all seems to be at around the £10k – £12k level. This got me thinking….
Assuming they were purchased 25 years ago with 100% LTV interest only mortgages, one could use the surplus income for years 1 through to 23 as you wished. Then, year 24 & year 25 apply all the rent to paying off the mortgage.
This is the benefit of having debt in an inflationary environment over a long enough time frame. You could strain yourself for years to pay off the debt or wait and let rents rise and debts get less and less expensive due to inflation.
What are your thoughts?
Thought 6
Romeo and Juliet each have the magic 52 properties in their portfolio (annual profit from 1 property to fund a weeks living costs!) and are now looking to stabilise and secure the portfolio for them and future generations. This is the conservative and sensible thing to do.
There are two key options to bring your LTV actively.
Romeo adopts the same philosophy of Tom in paying off the debt. By picking the worst rates and getting to 60% LTV he eventually gets all properties to this magic level. He then starts again and pays off the worst 60% rate mortgage.
Juliet takes a more aggressive approach to being conservative. Instead of doing what Romeo does, she instead buys property 53 for cash. In fact, all subsequent purchases are cash purchases. Her debt level – in absolute terms – does not decrease, it remains the same. However, her total asset value increases with each new purchase. This has the effect of reducing her LTV with each new purchase.
The total level of income is also increasing compared to Romeo as more properties are being added (and they have no mortgage costs associated with them).
The overall asset base is also increasing compared to Romeo which over time, should increase the equity and net worth of Juliet considerably over Romeo.
While Romeo will be debt free, Juliet will get her LTV to a very low, conservative level.
What are your thoughts?
Thought 7
Junior looked at his worst mortgage rate, say 6.4%, and looked at the net cash yield or ROI from a new cash purchase, say 9%, and thought his money would work harder acquiring assets for cash rather than paying off and reducing debt.
In broad terms, we are in the lowest period of the 300-off year history of Bank of England base rates so for a while this should be an easy calculation to do. When rates go to 10% plus then the case for reducing debt would be far stronger.
And Finally
There is more I could say but the above are some of the key thoughts I have on mortgages and the debate on interest only vs interest and capital repayment. Hopefully you have learnt something or at least considered your options available?
There are various keys to success, or things that tilt the odds in your favour. Finding a strategy that sits with your personality is one of the keys as well as one that is aligned with your network, capital, skills, time, etc. Your attitude to risk is also crucial as well as having a sustainable long-term vision for the business.
However, debt – even good debt – comes with a risk and being able to manage that risk is absolutely crucial. What we haven’t explicitly mentioned or touched on in any depth really is personal financial money management. If you are rubbish at this I would say just one thing: Learn to manage your money better!
This is a key skill not generally mentioned but is fundamental to your long-term financial success.
And if you know yourself, and haven’t worked on these personal financial skills, then paying off mortgages (even in the inefficient manner of paying them off equally), will over time prove far better than using the surplus funds to fund a lavish lifestyle.
A comment from my mentor…
My final comment on the debate of interest vs capital repayment, as quoted by one of my mentors, is: “There is no debate!!!”
