Is this a good buy-to-let investment?

Interest payments

There are two sources of interest that the ownership of a property costs.

• Mortgage interest
• Lost interest on other funds invested

The situation is best illustrated using an example.

Example -

You are interested in a house priced at £180,000. However you estimate that the real costs of preparing the property for letting is £200,000. This is to be financed using a buy-to-let mortgage of £150,000 and the remainder from savings.

The mortgage interest

You intend financing this with a mortgage at an initial fixed rate of 2%. Therefore the initial interest cost of this mortgage woudl be £250 per month or £3000 per year.

If you opt for a repayment mortgage then your initial mortgage payments will be higher than this as the repayments will consist of both an interest and a repayment component. Only the interest component should be considered as a cost of managing the BTL. The repayment component is more like a savings fund.

Note that the 2% interest rate is just an initial rate - perhaps it changes ot the standard variable rate which is currently 5% for a further 2 years. It is unrealistic to base all calculation just on a short term introductory interest rate. Either account should be taken of the variation in rates over time, or calculations shoudl be done based on a long term average interest rate.

Hence rather than assuming a rate of 2% for the mortgage it perhaps it woudl be better to take account of the temporal chnage - eg 2% for the first 2 years followed by 2 years at 5%, or perhaps simply work on the assumption that the average interest paid will be nearer to say 4% long term.

Interest rates are currently exceptionally low, so even if you planned on constantly remortgaging to stay on the best deal, it is unlikely that the rates available would be as low as today. Perhaps, rather than assuming a long-term rate of 4% it woudl be better to allow for rises in interest rates from the current level and perhaps assume a long term average rate of more like 6%. This woudl mean that rather than assuming mortgage payments of £3,000 per year based on the 2% interest, long term we actually expect to pay more like £9,000 interest on the mortgage each year based on a rate of 6%.

Lost interest on savings

In addition to having to pay interest on any money borrowed to purchase the property, you will also lose interest that would have otherwise been earned on savings that were used in the purchase. In the example, £50,000 was to come from savings. Assuming the average long term return that could have been obtained on this money was 4% then this equates to a loss of interest of £2,000 per year. However after tax for a higher rate 40% tax payer this woudl be , this woudl be more like £1,200 income actually lost.

Hence the annual interest payments associated with the example property are £9,000 for the mortgage and a further £1,200 for the lost interest on savings invested.

There are a number of other costs associated with managing the finance.