Welcome to our guide on interest-only mortgages for holiday lets.
If you’re considering investing in a holiday let, it’s crucial to understand the financial implications and options available to you. One such option is an interest-only holiday let mortgage.
Interest only is a popular choice for landlords when arranging a buy to let mortgage, as the cash flow is so much better. But does this also apply to holiday letting?
Let’s take a look at how they work, who offers them and how to get one.
Understanding Interest-Only Mortgages
Before we dive into the specifics, let’s first define what an interest-only mortgage is.
In simple terms, an interest-only mortgage is a type of loan where your monthly payments only cover the interest charged on the loan, not the capital.
The capital, which is the original amount you borrowed, remains outstanding and needs to be paid back in full at the end of the mortgage contract.
Now, how does this work in the context of holiday lets?
Let’s say you’ve taken out an interest-only mortgage on a holiday cottage. Your monthly payments will only cover the interest on the loan, not the capital. This means that your monthly payments will be lower than they would be with a repayment mortgage.
This is great for monthly cash-flow. However, you’ll still owe the full loan amount at the end of the mortgage term.
Conversely, with a repayment mortgage, as long as you maintain the (higher) monthly payments required by the lender, your mortgage will be fully repaid at the end of the term.
The Appeal of Interest-Only Mortgages
This financial flexibility can be particularly beneficial for property owners, especially during off-peak seasons when rental income reduces.
Here’s a quick example based on a £300,000 mortgage.
|Mortgage term||25 years|
|Interest only mortgage||£1250 per month|
|Repayment mortgage||£1753 per month|
Another advantage is the potential for voluntary overpayments. Most lenders allow you to make adhoc lump sum repayments at any point during the year, regardless of your chosen repayment method.
This means that if your financial situation allows it, you can choose to pay off more of your capital, reducing the amount you owe at the end of the mortgage term. This will also reduce the interest charged as the debt is lower.
Most lenders now allow a 10% overpayment allowance each year. But before you get the cheque book out, read through your mortgage contract for early repayment fees.
As an example: If you have a £300,000 loan, you could overpay up to £30,000 during the first year. The following year, with £270,000 outstanding, you could overpay up to £27,000, and so on, throughout the remainder of your mortgage contract.
This can be a great way to gradually chip away at the balance, as and when funds allow.
The Challenges and Risks
While interest-only mortgages offer certain advantages, they also come with their own set of challenges and risks.
The most significant of these is the large sum owed at the end of the mortgage contract. Since you’re not paying off any of the capital during the term of the mortgage, you’ll still owe the full loan amount when the contract ends.
This is why having a solid repayment plan in place is crucial.
Whether you plan to sell the property, use savings or investments, or rely on rental income to repay the loan, your lender will need to see proof that you can pay back the full loan amount.
If the lender is not comfortable with your plan they could restrict your mortgage to full repayment only.
How can a mortgage broker help?
This is where specialist holiday let mortgage brokers (like us) come into play.
A mortgage broker can help you find lenders who offer interest-only mortgages, assess your affordability, and devise a repayment strategy that suits your circumstances.
Not all lenders offer this option, and many only work with brokers. In addition, if your property is a mixed-use holiday let, or even multi-let, you will find it difficult to obtain competitive finance without a broker.
That said, you’ll get their help, advice, support and knowledge throughout the transaction.
Switching from Interest-Only to Repayment
There may come a time when you want to switch from an interest-only to a repayment mortgage.
This could be due to a change in your financial situation, such as receiving a pay rise or experiencing a rise in rental income. When you switch to a repayment mortgage, your monthly payments will increase as you’ll start paying off the capital each month in addition to the interest.
And by the end of your mortgage contract, you’ll have paid off your initial loan in full.
At this point you may want to look at the remaining mortgage term. If it’s too short then the monthly payments may be unaffordable. Your broker will be able to work out some figures to compare different durations to see which is best.
Switching mortgage types isn’t a decision to be taken lightly, and it’s here that a mortgage broker can provide invaluable advice. They can guide you through the process, ensuring you understand the implications of the switch and helping you assess whether it’s the right move for you.
Getting an Interest-Only Mortgage: Steps and Considerations
If you’ve decided that an interest-only mortgage is the right choice for your short term holiday let, the next step is to find a lender and secure your mortgage.
Here are some key considerations:
Deposit: Lenders often require a larger deposit for interest-only mortgages. The more you can put down as a deposit, the more likely you are to secure a favourable interest rate. This means a lower loan to value mortgage though.
Income: Lenders will want to see evidence of a good annual income. This gives them confidence that you’ll be able to pay off the capital at the end of the mortgage term.
Repayment plan: As we’ve mentioned, having a solid repayment plan in place is crucial. You’ll need to convince lenders that you’ll be able to pay back the full loan amount by the end of your contract.
A mortgage broker can guide you through these considerations, helping you present a strong case to potential lenders. They can also help you compare interest-only mortgages and secure the best rates.
If you already own the property then you may be able to remortgage your holiday let and change the repayment method at the same time.
Interest-only mortgages for holiday lets can offer significant benefits, but they also come with their own set of problems.
Whether you’re considering this type of mortgage or are looking to switch from an interest-only to a repayment mortgage, professional advice from an experienced mortgage broker can be invaluable.
As an independent broker advising on holiday let finance since 2006 we have a wealth of knowledge and connections, making sure our clients get the holiday rental mortgage they need.
So, if you’re considering investing in a holiday let, why not reach out for an initial discussion?
Call us on 020 8301 7930.
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