Interest-only mortgage and long term investment

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gearoidmm

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A number of threads on this site heve referred to people buying BTL properties as long-term investments with interest-only mortgages. In a significant number of these cases, the rental income does not cover the cost of the interest on the mortgage. When asked about the advisability of this, the response is invariably 'I'm in it for the long term -10-15 years'.

What I can't understand is how this could be a long-term investment. As far as I'm aware, interest only mortgages have to convert to regular repayment mortgages after a certain period. At that stage, the repayments would increase significantly and, given that the rental income is not covering the repayments now, it would imply that there would need to be a huge increase in rents in the next few years or else they would have to sell up and take the profit on capital gains. I can't see how this could be anything but a short-term investment.

Am I missing something here?
 
gearoidmm said:
Am I missing something here?
Click to expand...

Yes, you are misinformed about interest only mortgages on investment properties - and as an aside Bank of Scotland will do interest only on a ppr over 20 or more years.
 
Hi gearoidmm, I think that you have hit on one of the fundamental errors that a lot of property investors are making in that they are relying solely on future capital gains in order to justify their investment.

On the interest-only mortgage front (as far as I understand), the interest part of the repayments on an investment mortgage can be offset against the income tax that you would pay on the rental income. But this still leaves the minor issue of the capital that needs to be repaid. Given that rents in Ireland are not even keeping pace with inflation it is difficult to see how many property investors intend to repay the principal out of rental receipts alone.

Given the high transaction cost involved, property ought to be a long-term investment. But the phrase long-term' is increasingly being used to justify the purchase of an asset whose income falls short of the funding costs - the purchaser has no choice but to describe him/herself as a long-term investor!
 
I'm sorry but isn't the possibility of capital gains not an acceptable consideration in determining the investment risk. All of this waffle about keeping your analysis focused on rental income is really annoying. I am not saying the capital appreciation is going to do anything like it has done in the past, but to say it is essential to discount it from the equation is nonsense.

Determining risk (and therefore price) for share purchases is not confined to assessing the dividend levels. You assess the underlying asset performance in terms of ability to grow value, and any dividend that comes along is great. Neither of which are guaranteed, but the price / risk assessment should consider both.

The usual cautionary notes of course should apply, but why is one considered breaking the first rule of property investment if expected capital gain is considered part of the risk model.
 
NIB give the full term for 25 yrs
gearoidmm said:
A number of threads on this site heve referred to people buying BTL properties as long-term investments with interest-only mortgages. In a significant number of these cases, the rental income does not cover the cost of the interest on the mortgage. When asked about the advisability of this, the response is invariably 'I'm in it for the long term -10-15 years'.

What I can't understand is how this could be a long-term investment. As far as I'm aware, interest only mortgages have to convert to regular repayment mortgages after a certain period. At that stage, the repayments would increase significantly and, given that the rental income is not covering the repayments now, it would imply that there would need to be a huge increase in rents in the next few years or else they would have to sell up and take the profit on capital gains. I can't see how this could be anything but a short-term investment.

Am I missing something here?
Click to expand...
 
Hi ntoodeep,

I never said that is was essential to discount capital gains from the investment equation. My point is that relying solely on future capital gains is a relatively risky undertaking for what is essentially a leveraged bet on the direction of property prices.

Traditionally, the merits of property as an investment were judged more on the (net) rental yield rather than on the prospects for future capital gains.

I think that if the sums add up property can be a suberb investment for an individual, but current (Irish) property prices (in my opinion) do not make a compelling investment case. If a property is not generating a positive yield given how low current interest rates are, how is the investor expected to repay the borrowed capital? Outsize price increases cannot continue indefinitely so when the market cools to a more pedestrian rate of capital growth (say 5% per annum), this investment still makes little financial sense because it generates no income.

My point is best illustrated when you compare this type of property investment to buying a Eurostoxx 300 tracker. The transcation costs are substantially lower and the index yields just under 3%. Moreover, the stocks market also holds out the prospect of significant capital gains (having said this most European markets are now at 5-year highs but property ain't cheap either).
 
nt00deep said:
I'm sorry but isn't the possibility of capital gains not an acceptable consideration in determining the investment risk. All of this waffle about keeping your analysis focused on rental income is really annoying. I am not saying the capital appreciation is going to do anything like it has done in the past, but to say it is essential to discount it from the equation is nonsense.

Determining risk (and therefore price) for share purchases is not confined to assessing the dividend levels. You assess the underlying asset performance in terms of ability to grow value, and any dividend that comes along is great. Neither of which are guaranteed, but the price / risk assessment should consider both.

The usual cautionary notes of course should apply, but why is one considered breaking the first rule of property investment if expected capital gain is considered part of the risk model.
Click to expand...

Value in shares is built through growth in earnings or net income.
The same should be the case for property. Everybody forgets that an asset is something that produces a net income.
The promise of capital growth does not produce an income. It produces an emotional response that causes people to buy on this basis.

Absolutuely cap growth is important. But any property investr should first cover their risk by ensuring that rent not only covers the mortgage payments but provides a decent return over it.

Judging by this website, there are a lot of people buying properties that do not cover against this risk. These people are taking serious chances with their money and their homes because they do not understand the principles of investing. [ALWAYS COVER THE DOWNSIDE! i.e. if there was a property crash, would you be ok?]
 
Some posts here are scary, as scary as the GUBU property prices some people are prepared to pay and the risks some 'investors' are taking. When the tide turns, it's going to be horrible. BTW, Japan's property market crashed 15 years ago -- and it still down there.

Two principal market characteristics are greed and fear. The greed is rampant , but just wait for the fear and loathing. I'm glad I'm not involved directly. Anyway, time for a pint!
K
 
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