Why Savvy Northampton Buy-to-Let Landlords Don’t Use 10-Year Mortgages
And the reason you shouldn’t either
I know of many Northampton buy-to-let landlords who fell into property investing by accident. Many didn’t want to sell their family home when the Northampton housing market crashed in the Credit Crunch of 2009/10, yet still needed to move (often for work). They thought they would keep their Northampton family home in case they ever moved back to Northampton. Yet by keeping it, it couldn’t remain empty (there was still a mortgage to pay on it), so they ended up renting their home out. And that was the start of many Northampton buy-to-let landlord's journeys! Many of you Northampton landlords reading this have had your fair share of problems, from tenants doing a midnight flit, rent arrears and troublesome tenants, yet also had your rewards. The average Northampton landlord in the last ten years has seen their investment rise by an average of £108,100 and has earned in rent (before costs) £103,488. Many of you reading this have started to learn about investing and creating a property portfolio by buying additional Northampton homes to rent. The average Northampton buy-to-let landlord now owns 3.38 properties that generate an impressive passive monthly income with the bonus of growing their household net-worth through growth in the value of their buy-to-let portfolio. With the average Northampton buy-to-let landlord in the 56-to-58-year age range, one thing I learned about savvy buy-to-let investing, the shrewd Northampton landlords tend to want longer-term mortgages. Taking longer-term mortgages reduces the risk to the landlord. It sounds counterintuitive, yet it comes down to leverage. Let me explain that whilst leverage is formidable in buy-to-let, it is also quite risky. Before I explain why some readers might not know what leverage is and how it relates to mortgages and buy-to-let, two-thirds of landlords are debt-free, yet those landlords who have come into the property investment games in the last 10 or 20 years have had to use borrowed money (mortgages) to finance their deals. Therefore, by putting down a small amount of say 20% and borrowing the other 80%, if you calculated your return on an investment base only the money that you put into the deal, then that is what is called leverage (i.e. using borrowed money as a funding source when investing in property and generate greater returns on borrowed money). You would think, as, say a typical 55-year-old Northampton landlord, you would want to be only taking a mortgage out for however long you intend to work (say ten years at most) – meaning your portfolio would be all bought and paid for by the time you retire. Yet the clever buy-to-let Northampton landlords I talk to don’t see their portfolio as having to be paid off (and mortgage-free) by the time they retire. They have understood how to utilise and administer their mortgage debt rationally to enhance their returns without taking on unwarranted risk. By taking a short-term mortgage of say ten years, compared to a 25-year mortgage, during those ten years, your monthly mortgage payments will be particularly high (because the longer the mortgage term, the smaller the monthly payments will be). Also, you can pay off a 25-year mortgage in 10 years, but you cannot pay off a 10-year mortgage in 25 years. Longer mortgage terms mean lower monthly mortgage payments, which in turn means greater cash flow and more elasticity within your rental portfolio. Now to some Northampton landlords, possessing their rental properties debt-free is very important. Yet, I would still seriously consider taking the 25-year buy-to-let mortgage and make additional payments every month to help you to pay the mortgage off early … Therefore, if for example, you have a bad couple of months without any rent coming in or unexpected bills, you can return to making the mandatory lower monthly mortgage payments without getting your property repossessed. So, by taking on the longer-term mortgage, you decrease your risk because it has the lower required payments. Let me give you an example - if our Northampton landlord wanted to buy a Northampton terraced house property for say £213,500 and put down a 25% deposit of £53,375, the best buy-to-let deal I found online on the day of writing this article was a 1.79% Santander 5-year fixed-rate buy-to-let mortgage. Looking at the mortgage payments per month when comparing the mortgage terms; on the 10-year mortgage, the mortgage payment would be £1,471.22 per month. Therefore, our landlord would have to top up from personal savings to make up the monthly mortgage payments. Whilst if they choose the 25-year mortgage, the mortgage payment would be £676.36 per month. This would mean our landlord would be in profit from day one. Some might say though the longer term means more interest payments, as it's 25 years and not 10 years. Yet, at today's low interest rates, that would only mean an additional £26,362 in interest payments spread over 15 years – not much in the grand scheme of things.
Therefore, by taking the longer-term mortgage, as a savvy Northampton landlord, you are 'cash flow positive’, meaning you can build a reserve fund for every one of your rental properties to enable you to deal with any unforeseen voids and repairs.
The best way to deal with a buy-to-let property is to see it as a small mini-business, and as with all businesses, you need to grow your income and reduce your expenses whilst in the background provide a decent rate of return for your investment.
The greater the amount of mortgage debt you carry, the greater your monthly mortgage payments, and the simple fact is, the shorter the mortgage term, the higher the monthly mortgage payments. So, if you take on a sensible level of mortgage debt and be ‘cash flow positive’, you can profit from much better returns without taking on excessive risk.
These are my thoughts -please share yours.
P.S. Before I go, I have to say this to cover my proverbial. My comments are only a very brief commentary on the issues raised and should not be relied on as financial advice and that no liability is accepted for such reliance, and that anyone needing such advice should consult a qualified financial adviser or other authorised person.