Mortgage vs. cash - which delivers better return?
Can't decide whether to buy a property with cash or get a mortgage? Security is a major benefit to being able to buy your house outright. You know the property is 100% yours and you're not burdened by monthly mortgage payments. But when you're talking about a buy-to-let property, your priorities are likely to be a little different, and buying a house with cash, of course, isn't an option for everyone.
Property expert Kate Faulkner explores the key things to consider when investing in a property.
The capital growth benefit of having a mortgage
Regardless of whether you own a property outright or put down a deposit and borrow from the bank, any capital growth is yours to keep (minus whatever capital gains tax might be payable). So, if you have a mortgage, you're benefitting from growth on the bank's money as well as your own. That means you could make a significantly greater profit by splitting your capital across several properties, rather than putting it all into one.
As a simple example:
- You buy one property for £350,000 cash. If prices rose by 10% over time, it would give you an additional £35,000 equity.
- Now let's say you use the same £350,000 to buy four properties, putting down a 25% deposit of £87,500 on each one and borrowing the rest via a mortgage. If prices rose by 10%, the four properties would give you an additional £140,000 equity - four times the gross profit.
You would of course incur additional costs in buying four properties versus one property, but this shows how gearing versus investing 100% in cash can increase your returns.
We've based the figure of £350,000 on the average house price of £372,436 in England and Wales, according to the LSL Property Services, April 2022 index.
The impact of a mortgage on rental profits
Despite having more properties, and therefore receiving more rent, mortgage payments can reduce your overall monthly rental profits.
We've taken the average monthly rent in the UK - and assumed an interest-only mortgage at 5% interest - to analyse three different scenarios, each employing £350,000 of capital investment:
| One property | Two properties | Four properties | |
| How the property was funded | 100% cash | 50% LTV | 75% LTV |
| Capital invested | £350,000 | £350,000 (£125,000 x 2) |
£350,000 (£87,500 x 4) |
| Mortgage borrowing | £0 | £350,000 (£125,000 x 2) |
£1,050,000 (£262,500 x 4) |
| Monthly rental income | £1,159 | £2,318 | £4,636 |
| Monthly mortgage payments | 0 | £1,458.33 | £4,375 |
| Rental income minus mortgage | 1,159 | £859.67 | £261 |
The average monthly rent figure is based on the Homelet.co.uk rental index, September 2022.
We've assumed an interest-only mortgage at 5%. This is the approximate rate most two and five-year fixed deals currently revert to after the initial period, although this can vary. The above figure is only used as an example.
The rental profit in this example decreases with each additional property. However, if you're buying in an area and market where property values are increasing year-on-year, the extra capital growth you'll benefit from could help to cover some reduction in rental profits.
These figures relate to a property let on a single Assured Shorthold Tenancy (AST). If you work out figures for houses in multiple occupation (HMOs), where rental income and monthly rental profit is usually considerably higher, splitting your investment capital across several properties could prove beneficial. That being said, as with any financial investment, you should always analyse the figures for your own circumstances and carefully consider what is appropriate for you. It's important to keep in mind the impact changes in interest rates and house prices would have on your finances.
Importantly, make sure you're happy with the amount of mortgage debt you're considering taking on. To help, it's worth considering mortgage insurance, which covers your monthly payments if you lose your job or become ill, giving you peace of mind for up to two years. In addition, rent guarantee insurance may be worthwhile if the tenant isn't able to pay.
Additional borrowing on mortgage
If you're considering buying a property that needs refurbishment, or plan to improve one you already own and don't have the cash available to pay for works, speak to a mortgage broker about borrowing more. Putting additional borrowing on your mortgage can cost you less over time than taking out a personal loan or using credit cards.
Buying a house with cash
Comparing the benefits of purchasing a buy-to-let with cash versus a mortgage really relates to how you hold property long term. There are significant benefits to buying a property with cash:
- You can move on a deal quickly. You don't have to go through the mortgage application process, so sellers may favour you over other potential buyers.
- Because you can move quickly, you're in a great position to negotiate a lower purchase price if the vendor is in a hurry to sell.
- You can purchase properties with cash that are unmortgageable, for example, a short-lease property or one which has subsidence. As long as these are cost-effective to fix, you can secure good capital gains once the lease is lengthened or structural issues fixed. At this stage you can then consider re-mortgaging, although this may take six months to achieve.
To work out the best way of financing a new property or your current portfolio, talk to an independent financial advisor to ensure you have a long-term plan and discuss mortgage options with a qualified broker.
The benefits of investing in property
One of the benefits of investing in property is short-term letting. Similar to a 'holiday let', short-term letting is where a room or property is let for a short period of time, compared to a long-term let, which is generally regarded as anything over six months. There are many positives to running a short-term let, such as higher rental amounts and a potential holiday home for yourself, but there are legal requirements that you'll need to consider.
Please note, the above information is a brief guide only to buying a house and the options that are available to you as a landlord. There are potential pitfalls with any form of property investment, therefore this article shouldn't be taken as advice.
An original article was created using advice from one of the UK's leading, independent property experts, Kate Faulkner, which we've updated with new information.
Kate Faulkner
Last Updated: 10 Jan 2024
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