Updated: Jul 5, 2020
Should I buy with cash?
One of the biggest advantages of buying an investment property in cash is not having to pay back a loan and interest on the borrowed money however does this outweigh the option to use a leverage (a mortgage)?
Let`s take a look at some further advantages It’s a common belief that a seller is more likely to accept a lower offer if the offer is for cash however not all sellers need to move quickly, and some are more than happy to wait it out for a mortgage buyer.
As a cash buyer you would avoid the mortgage application process making the purchasing of a property far easier and quicker.
What about the disadvantages? As a cash investor you will receive a lower return on your investment as you have put more capital into a deal.
What is leverage? ‘Leveraging’ is using other people’s money to acquire assists which in turn makes a higher return on your initial investment.
What are the advantages of using leverage? If you use leverage (a mortgage) to invest in a buy to let property you will making a profit on an asset that you have paid for with someone else’s (the banks) money.
One of the advantages of buying an investment property using a mortgage is the increased return on the capital you have invested.
If the buy to let property is bought with a limited company the investor can of set the mortgage interest against the rental income this has a huge tax advantage.
Let`s look at a couple of examples
A cash purchase
You buy an investment property for £100,000, you rent it out and achieve a 7% annual yield.
You earn £7,000 per year before costs.
Your costs (management fee, maintenance, insurance, repairs etc) came to £1,500
You are left with £5,500 or 5.5% return on your investment (before income tax)
A purchase using a mortgage
If you recreated the same deal using a 75% loan to value interest only mortgage.
Meaning you would use £25,000 of the £100,000 as a deposit.
You still receive the same £7000 gross income.
Your costs would still be £1,500.
If your mortgage interest was 3.75%.
You pay £2,812.5 in mortgage interest.
Your net income is now £2687.5 or 10.75%
If you were to replicate this across 4 buy to let properties your annual net profit would be £10,750, double what it would be if you only bought one property in cash.
However, you will of course still be required to repay the mortgages on now 4 properties if one property has a void in tenancy, there could still be rental income coming from the other properties.
The downside is that there is a mortgage payment that must be met, whether the property is let or not.
Ways to repay an interest only mortgage
· Re mortgage to a better mortgage rate, switch to a repayment mortgage and repay the loan over a longer term to make monthly payments more affordable.
· Sell the property to raise the funds and pay back the loan in a lump sum at the end of the term.
· Pay into an investment plan which can then be used to pay off the loan amount in a lump sum at the end of the term.
· It`s also possible to make lump sum over payments on some mortgage products
· Leave your properties to executors in your will. You can leave everything to a spouse free of inheritance tax and you get a £325,000 tax-free allowance when you die, plus up to £125,000 extra if your estate includes a family home, as long as you leave it to your children. If you’re a widow or widower and you inherited your late spouse’s entire estate, you can also claim their tax-free allowance, meaning you could leave up to £900,000 tax free.