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Monday, July 28, 2008

Buy-to-let mortgages- return to endowments?

As an investor and property investor I have found that sometimes challenging the conventional wisdom has resulted in some of my best investment decisions.

Take for example my decision in the early 90s to disregard the doomsayers who predicted that residential property would take a decade to recover in value and those investors in the share markets in 2003 that predicted that we were in for a long run bear market. Both decisions to invest when others were fearful rewarded me handsomely.

Where do professional landlords go for their landlords insurance?

Thinking outside the box
Sometimes landlords and investors need to think outside the box as they say to really maximise their investment returns. All this leads me to my latest idea.

Endowment mortgages
Does anybody remember the ill feted endowment mortgage? These financial tools are probably familiar to anybody who remembers the Human League and wedges. For those younger landlords they are probably a mystery. I remember my father trying to explain them to me once. In essence old school endowment policies were savings vehicles which had the objective that they would rise in value sufficiently to pay off the outstanding mortgage at the end of the loan period. This in theory allowed the mortgagee to pay the interest on the loan in the certainty that the endowment policy would clear the loan at the end of the mortgage period.

Everything went swimmingly for several years as returns on these endowment policies easily outstripped their projections because of booming share prices which meant that many investors ended paying off their mortgage and also having a tidy profit on their investments after the mortgage had been paid off.

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However, the wheels all started to fall off the cart in the 1990s when it became apparent that the returns being obtained on endowments were no longer enough to pay off the mortgage, let alone produce a profit. From that point on the endowment mortgage waned in popularity to the point that they are now probably as popular as the Human League and the wedge cut.

Buy-to-let endowment mortgages
Unfortunately, as far as I am aware there has never been an endowment investment mortgage for landlords. This is a shame because landlords are just the type of mortgagee that could benefit from this type of investment product. Why is this? Well unlike a owner occupier a landlord is less dependent on when they repay their mortgage. Many owner occupier need to time the repayment of their mortgage to a point when their income changes, such as their retirement. Landlords who are in receipt of a rental income often do not have the same financial constraints. There are therefore more flexible about when or if their buy-to-let mortgage is repaid.

Self select endowment
This brings me to my 'big idea'. Many landlords do not have a buy-to-let mortgage at all. Latest statistics show about 40% of buy-to-let property has no mortgage. This means that many landlords could raise relatively large sums of money by obtaining a mortgage on their investment property at relatively low rates of interest. This is because despite the 'credit crunch' lenders still see lending to landlords as a relatively low risk activity. I've been speaking to the brokers at Mortgages For Business and they have given me several buy-to-let mortgages around the 6-6.5% mark. Having secured a buy-to-let mortgage then landlords are able to arbitrage the differential in rates of return available in the equity markets which are now 10%+ with the cost of borrowing on their buy-to-let mortgage. The result is that it is now possible to generate a 5% differential on the income derived from the portfolio that a landlord invest their funds in and the cost of the buy-to-let loan.

The figures
Landlords can then use their self select endowment fund to repay their mortgage. For example the monthly costs of a £70,000 buy-to-let loan are £367 in interest on a pay rate of 6.29% or £602 for a 15 year repayment mortgage.

The return on this £70,000 could be £612.5 month on a projected investment income of 10.5%. This means in theory the buy-to-let loan could be paid off in 15 years.

This all means that it is possible for a landlord to use the income from their buy-to-let self select endowment to repay their buy-to-let mortgage. At the end of the mortgage period landlords are still left with their endowment fund which hopefully if invested wisely will be worth more than what it was purchased for.

The result for a landlord could be a:

a. buy-to-let mortgage that is repaid
b. separate endowment fund with its own income generating properties
c. potential profit on the endowment fund from any capital appreciation

It all makes you think doesn't it. I'll keep landlords posted with the progress of my new idea.


james michaels said...

Interesting argument I've never seen before, given the reputation endowment mortgages have recieved it would be a touch sell for any company offering.

The problem with endowments was their unrealistic expectations, if the landlord endowment ever did take off they'd have to be realistic.

Anonymous said...

With endowments you get what you pay for. If you get a full with profits endowment the loan is guaranteed to be repaid. If you do what most people do and get a low cost endowment you have a guarantee that approximately 60% will be paid. Which is really no big deal for a btl investor. What I want to know is if I plough the monthly return into an endowment do I have to pay tax on it?