Are you a Landlord with an Interest-only Mortgage?

As a landlord, you may have taken out an interest-only mortgage on your rental property in the hope of maximising your profits. However, with interest rates rising, many have found that their profit margin is being squeezed as they come to renew or feel the impacts immediately due to having variable trackers. In this blog post, we’ll explore why this is happening and why landlords may consider selling and investing in alternative asset classes.

In the last twelve to eighteen months, we have seen interest rates rise in general which has led to a reduction in landlords profit margins. This has left many landlords with the difficult decision of whether to sell their properties and invest in alternative asset classes or increase their rents and hope their tenants do not leave.

Interest-only mortgages have been popular amongst landlords because they allow for lower monthly payments, which can increase the cashflow generated by a rental property, although they are normally subject to higher interest rates than a conventional repayment mortgage. However, interest only mortgages do not require the borrower to pay down the principal balance of the mortgage, which means that the balance remains the same throughout the lifetime of the mortgage.

As you do not build equity throughout the time of the loan by making capital repayments, you are reliant on the value of the property increasing over time if you are targeting capital growth. It is therefore possible that if property values fall, landlords may end up owing more on the mortgage than the property is worth. This problem could further be compounded by needing to sell when there is an influx of properties into the market.  

With the reduction in profit margins, landlords are no longer generating the same level of income they were a few years ago, which is of significance if it is relied on as a source of income. Added to this is the fact that landlords only receive a tax credit of 20% of the interest costs and having to improve the energy efficiency of the property to meet minimum regulations by 2028. Plus, with it become increasingly difficult to evict bad tenants, many landlords are now questioning if it is worth it and looking at investing in alternative asset classes.

Alternative asset classes can provide landlords with a more diversified portfolio and potentially generate higher returns over the long term, with no ongoing maintenance, legal or insurance costs. For example, investing in stocks, bonds, or property targeted funds such as ‘Real Estate Investment Trusts (REITs), can provide landlords with exposure to a broader range of asset classes and markets, which could be held on a single investment platform.

Utilising other asset classes can help reduce the overall risk of a landlord’s portfolio which typically comprises solely of property and based in one geographical location. One might consider what would happen to London property prices if the government were to introduce stricter measurements and criteria for foreign investment?

From a taxation point, some landlords may find themselves with sizeable unrealised profits on their property/properties which could be realised, although subject to taxation on the gain at 18% or 28% dependant on their personal tax positions. We have also seen the capital gains tax annual exempt amount reduce from £12,300 to £6,000 this tax year, with a further reduction down to £3,000 due for 2024/25.

Whilst a marginal benefit, this could be a good opportunity to lock in any gain and make the most of the allowance whilst it is still available.  Other asset classes could be held in tax efficient vehicles such as Stocks & Shares ISAs, allowing your portfolio to target growth in a more tax efficient manner and with far greater liquidity.

Finally, having investment property provides you with limited inheritance tax planning opportunities, meaning that you may not be able to pass on your rental property to your beneficiaries without you or them incurring significant tax liabilities. This also limits the options of your executors who need to settle any inheritance tax before probate can be granted.

To summarise, property has for most been a good investment over the last 10-15 years with property prices increasing and historically low interest rates on mortgages. However, with the changes in legislation, tax treatment, higher interest rates and a cost-of-living crisis, it could be the time to sell.

Of course, the actions you take will be driven by your own circumstances and financial/life objectives.

CLICK HERE to get in touch should you wish to discuss your options or talk through some potential scenarios.