Buying a house: mortgage vs. cash - which delivers a 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 is not necessarily the best way to secure the highest return on your investment.
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 £200,000 cash. If prices rose by 10% over time, it would give you an additional £20,000 equity.
- Now let's say you use the same £200,000 to buy four properties, putting down a 25% deposit of £50,000 on each one and borrowing the rest via a mortgage. If prices rose by 10%, the four properties would give you an additional £80,000 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.
The impact of a mortgage on rental profits
Although you might think you're making a huge saving and increasing your monthly rental profits by not having to make mortgage payments, if you have more properties, you'll obviously receive more rent.
We've taken the average monthly rent for England and Wales* - and assumed an interest-only mortgage at 5% interest** - to analyse three different scenarios, each employing £200,000 of capital investment:
|One property||Two properties||Four properties|
|How the property was funded||100% cash||50% LTV||75% LTV|
(£100,000 x 2)
(£50,000 x 4)
(£100,000 x 2)
(£150,000 x 4)
|Monthly rental income||£861||£1,722||£3,444|
|Monthly mortgage payments||0||£833.32||£2,500|
|Rental income minus mortgage||£861||£888.68||£944|
*According to LSL Property Services, June index, figure for April 2018 (seasonally adjusted)
**The approximate rate most two and five-year fixed deals currently revert to after the initial period
While the rental profit in this example increases slightly with each additional property, there will be other maintenance and administrative costs to consider. Even so, 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 should cover any minor reduction in rental profits many times over.
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 certainly seems to make sense. That being said, as with any financial investment, you have to analyse the figures for your own circumstances and carefully consider what is appropriate for you.
Importantly, you must 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.Rent Guarantee is purchased as part of Legal Expenses add on at New Business or Renewal. Eviction notice must have been correctly served before a claim. Restricted claims for existing tenants in first 90 days after purchase. Residential landlords only. Maximum 12 month claim period. Excludes prior losses and rent reduction. Excludes rent arrears while possession proceedings are delayed/prevented by legislation, government or court. Qualifying criteria apply.
Additional borrowing on mortgage
As well as potentially boosting your returns, taking out a mortgage is usually the cheapest way to borrow money, especially while interest rates are low.
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 remortgaging and releasing some equity. 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.
Kate Faulkner is one of the UK's leading, independent property experts and regularly features in major newspapers, on the BBC and ITV, as well as regularly co-hosting the Property Show on LBC.
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