Buying outright vs. Interest Only Mortgage - Am I overcalculating?

trelloskilos

Hi all

I've been trying to do the maths on this one, and either I'm overlooking something, or my initial preconceptions that buying outright is more profitable than getting a mortgage, are completely wrong.

I've simplified the figures below, a little, and not taken into account various fees (solicitors fees, service charges etc., but I believe the principles are still the same...!)

Here's my situation:
I have found a property that I can buy for £100,000. I intend to buy it for the purpose of renting it out. My research has led me to expect £750pcm (£9000 per annum) for the property.

Assuming I just buy the property outright, and later, sell on, I could expect a % return on my initial investment of 9% per annum (not counting additional solicitors fees, service charges etc.)

That's quite a good return, but I was looking at getting an interest-only buy-to-let mortgage at 4%, with an initial outlay of £30000

So, basically, my mortgage would be for £70000. The mortgage company would expect me to pay £2800 per annum

This would mean that my initial outlay of £30000 would see a return of £6200 (the £9000 annual rent minus the £2800 to pay the mortgage)

By doing this, my % return with a much smaller outlay would seem to be much larger! Roughly 20.6%!!!!!

If I used my £100,000 to buy the one property outright, I would end up with £9000 per year. But if I used that £100,000 to get 3 identical properties, each with an outlay of £30,000, and a 5% interest only mortgage, and recieve identical rents, I could end up with potentially £18,600 per year, and still have £10,000 left in the bank!

Either I've worked myself into a financial equivalent of that old maths chestnut about the 3 men and the £25 hotel room, or the maths is sound, and I would be better off getting the mortgage than buying a property outright!

Is my maths sound? Is this how budding property developers and landlords work? Or have I got something horribly wrong?

I know this is hypothetical, and the figures are not strictly accurate, but rounded up for clarity, but in a real-world situation, are there any other risks I should be aware of?

Many thanks for your help!!

holly_hobby

From a tax point of view on any commercial venture, you are better off with a mge as you can offset the mge interest charges against your rental income (in conjunction with other associated property costs) - thereby reducing the tax payable.

Also, you will have capital reserved to support any maintenance costs etc, and act as an emergency fund for yourself.

Hope this helps

Holly

blacksta

Your assumption is also based on the factor that the three properties are fully occupied for at least 12months

antrobus

I haven't checked your arithmetic. But the basic principle is correct. If an asset costing £100,000 will yield 10%, and the cost of borrowing is 5%, then if you borrow £50k to finance the £100k asset it will boost the yield to 15%. That's gearing for your. Or leverage as the colonials call it. And yes that's exactly how a lot of people played the BTL game.

The downside is that this higher yield comes at the price of higher risk. You've got the risk that the cost of borrowing might increase for one thing, but the main risk is that it multiplies the potential profit/loss from changes in the asset price. If you were to buy three £100,000 properties as opposed to one, then you have three times the exposure to any changes in house prices. If house prices were to fall by another 10% you'd lose £30k rather than £10k. And conversely if house prices were to rise you'd make three times the profit. You pick the level of risk you're comfortable with.

ManicMum

Also, if you buy outright, you are then losing interest on your 100k (though probably not too much to get excited about right now). Also, the mortgages have to be repaid at some point so would you need to factor a portion of your rent to pay them off? SOme people just hope the value goes up over time (which it normally does but these are not normal times) so they can sell and then pay it off. But if you pay off the mortgage as you go, then when you sell, you get to keep the lot. (minus CGT etc). Think I'd go for something in the middle - not to buy outright but don't think I'd leap in buying 3 properties. see how you go and then you can always get another.

Mrs_Z

Nothing wrong with your calculations per se, but you might also want to consider that

a) if you buy property outright, you dont have to pay off the mortgage payments from the rent, therefore your profit will be bigger, but this in turn means that you have more tax to pay (depending on your tax status).

b) have you considered how much the property will cost you over 25 years? If you pay outright, that's the cost upfront and if you sell, you'll (hopefully) get £££s. If it's interest only, what is the total that you would have paid back, ie. £100,000 + all the interest over 25 years, how much will that total? You could argue that the mortgage paymets (interest) are paid by the tenant, and yes, they are, except when there are voids, but it's still profit that would be in your pocket had your paid for the property outright.....

So not straight forward. You initial calculations are correct, but they only represent the picture at the start of the project - do the sums over 25 years, and the picture will be somewhat different.