Should I use my pension lump sum to pay off the mortgage on my buy-to-let? DAVID HOLLINGWORTH replies
- To ask your own mortgage question email: [email protected]
I have a second home, a small two-bed flat, which I own with a £93,000 repayment mortgage fixed at 2.69 per cent until October 2025.
The mortgage is set to be paid off in October 2035, and my main home is already paid off. Currently, my daughter lives in the second home rent-free.
Once she moves out later this year, I need to consider whether to change the mortgage to buy-to-let and rent the property out.
Early rental valuations indicate that the rent will cover the mortgage.
I have recently retired, although I am not due to get my state pension for another seven years.
Should I use the tax-free pot from my private pension to pay off the mortgage and use the rental amount as monthly income? What should I take into consideration?
![Banking on buy-to-let: Is it a good idea, and should this reader pay off the mortgage on the property he plans to rent out? David Hollingworth replies](https://i.dailymail.co.uk/1s/2024/08/12/11/88436443-13734999-image-a-1_1723459169702.jpg)
Banking on buy-to-let: Is it a good idea, and should this reader pay off the mortgage on the property he plans to rent out? David Hollingworth replies
SCROLL DOWN TO FIND OUT HOW TO ASK DAVID YOUR MORTGAGE QUESTION
David Hollingworth replies: Congratulations on your recent retirement which I hope you're enjoying. Of course, retirement brings certain considerations from an income perspective.
It's natural that you're considering how best to deploy your existing assets, and whether you should pay off some of your outstanding liabilities to get the best overall result.
The good news for the existing mortgage on the second home is that it's currently at a low rate, when compared to those that could be secured in today's market.
The fact that it's been providing a home for your daughter means that you've possibly not previously considered an alternative approach to the property and the potential to let it.
> Need a new buy-to-let mortgage? Check the best rates you could apply for
Letting could deliver an income that would not only cover the mortgage, but also provide some additional income to bolster your retirement.
The current mortgage was presumably agreed on the basis of the property being used as a second home, rather than as a buy-to-let.
If so, to avoid breaching the terms of the mortgage when you start to rent the second home out, you would need to seek consent to let the property from the current lender.
There's no guarantee that a lender will give their consent, and even if they do it could come with a cost.
Lenders may be more likely to give consent where the period of letting will be for a particular reason, especially if for a temporary period.
Depending on the lender, they may charge a fee or load the interest rate if they do give consent. However, that could still be the preferred route as the existing rate is low.
An alternative option that would allow the mortgage to continue would be to remortgage and switch to a buy-to-let mortgage, although that would incur an early repayment charge.
Buy-to-let lenders will want to be able to see that the rent will cover the mortgage interest by a certain margin.
Rather than using the mortgage rate, the interest calculation will often be conducted using a higher, stressed rate.
That will again vary by lender and can depend on your individual situation and product choice.
For example, the stress rate applied can be different depending on whether the landlord is a basic or higher-rate tax payer, recognising that only basic rate tax relief applies to mortgage interest for tax purposes.
Similarly, a lower stress rate is likely to apply for a five-year fixed rate for a like-for-like remortgage.
![Something to consider: Buy-to-lets might soon be required to meet energy efficiency standards, which could mean you have to spend money bringing this property up to code](https://i.dailymail.co.uk/1s/2024/08/12/11/88436623-13734999-image-m-13_1723459308897.jpg)
Something to consider: Buy-to-lets might soon be required to meet energy efficiency standards, which could mean you have to spend money bringing this property up to code
A lender may require the rental income to cover the mortgage interest by 145 per cent calculated at a rate of 2 per cent above the mortgage rate for a shorter-term deal.
Depending on the situation, lender and product, a £93,000 mortgage could require a rental income of anything between £500 to £800 per month.
Most buy-to-let landlords will take the mortgage on an interest-only basis, as they would plan to repay the mortgage when they sell the property.
However, you may want to reduce the mortgage over time if you'd like to retain the property as a longer-term income source and not have a mortgage to worry about.
Buy-to-let products will typically carry higher interest rates than standard mortgage deals. Fees can also be high and many of the lowest rates will carry big fees, some charged as a percentage of the mortgage.
Also think about other costs of running a buy-to-let such as letting agents, as well as the potential for rental voids if the property is left empty, for example between tenants.
Would that leave you with no income, and would you be able to pay the mortgage?
There's also a good chance of tougher minimum energy performance requirements for buy-to-let properties in the future, which you should factor into your longer-term thinking.
If there's a need for energy efficiency improvements to hit a minimum C rating on your Energy Performance Certificate, you may face further expenses.
Deciding whether to use the pension lump sum to pay off the mortgage altogether isn't a black and white decision.
The bottom line is whether you think the saving in mortgage interest will be enough to outstrip the return you could make within the pension.
You can't know how the pension funds could continue to grow, and whether it could potentially generate a better income than the rental property in the future.
Maintaining the mortgage in the meantime could help you understand the metrics better, and although relief on interest is not as generous as in the past, you can claim at the basic rate.
However, make sure you have ample funds in the background, as you will need to meet the mortgage payment even if there's a period without tenants.
If you can get consent from your lender it would give you a period at a good rate, avoid any early repayment charge.
You would also get a good idea of the costs and practicalities of being a landlord, without having to rush into a decision about your pension.