Investors tempted by attractive buy-to-let mortgage packages

Budget incentives have brought home-owning investors to the residential market looking to buy a second property, writes Clare O'Dea

The investor-friendly measures introduced in Budget 2002 have sparked renewed interest in residential property investment. Financial institutions are introducing attractive buy-to- let packages and predicting that investors could account for one-in-five mortgages drawn down this year. That's twice the level of investor participation seen in 2001.

While this is depressing news for first-time buyers, it should improve the supply of accommodation for the estimated 250,000 people competing for places in the rental sector and help stabilise rents.

The main player in the residential property market is the professional investor with more than three investment properties, according to IIB Homeloans. However, there has been a significant increase in the number of private investors arranging to buy a second home since the beginning of this year. The bulk of "professional investors" are public-sector employees, IIB says.

The short-term outlook for the residential investment market is good. Besides the restoration of mortgage interest relief and the reduction in stamp duty, there are several other factors driving this market. These include low interest rates, availability of finance and continued strong demand for rental accommodation linked to demographics and affordability barriers.

Recent bad experiences in stock market investment have also reinforced the traditional appeal of property.

Of course, every non-guaranteed investment carries with it an element of risk. Some investment properties will do better than others and the key performance factors will be location and access to transport. The best locations are those where there is a large catchment of younger people looking to rent and where demand continues to outstrip supply.

So what are the mortgage options for first-time investors who have already built up some equity in their own homes? First-timers can usually borrow up to 90 per cent of the value of the property they are buying to let. Those who are interested in using existing equity to purchase the second property may be permitted to borrow the full value of the second property, as long as the combined loan-to-value ratio of the two properties is not greater than 80 per cent.

For example, take someone living in a property worth €250,000, with an outstanding loan of €100,000. That person can potentially make use of €150,000 equity. If they were planning to borrow 100 per cent to buy a property worth €200,000, the two loans would add up to €300,000. The value of both properties would add up to €450,000, giving a combined loan-to-value ratio of 66 per cent, well within the 80 per cent limit.

There are other costs associated with buying property; the biggest is usually stamp duty (€8,000 in the example given above). That cheque has to be handed over to the solicitor on the day the sale closes and paid to the Revenue Commissioners within a month.

First Active has said it would consider lending more than 100 per cent of the value of the investment property to cover stamp duty and other costs as long as the combined loan-to-value ratio did not exceed 80 per cent. This is a scenario where no money would be required to make money, just equity.

There is an age restriction for this kind of mortgage - the general rule of thumb is that the age of the borrower plus the term of the mortgage should not add up to more than 70. However, most lenders will look at individual cases and may make exceptions.

Since the reintroduction of mortgage interest relief, different variations of interest-only mortgages have been mushrooming. With standard annuity mortgages, the borrower pays back capital and interest each month. In the early years of the mortgage, interest takes up most of the repayment and towards the end of the term, the borrower is paying back mostly capital.

An interest-only mortgage does exactly what it says: the borrower only pays back the interest and the capital remains untouched.

Mortgages that are interest-only for the initial years are attractive now because, through them, landlords can maximise mortgage interest relief. The monthly repayments are also lower.

Most lenders are offering three to five years of interest-only, but Bank of Ireland recently introduced a 10-year, interest-only mortgage.

So what happens after the first three, five or 10 years? Well, the capital remains static so the investor will still owe the original amount borrowed. Those who are taking a short-term view may be planning to sell anyway and they would be banking on the appreciation in the value of the property. For those who want to hang on to the property, the loan can be flipped over into regular capital plus interest repayments. This would produce quite a jump in the monthly repayments.

Interest-only mortgages are not the norm. IIB Homeloans estimates that 25 to 30 per cent of investors opt for interest-only. The majority still want a repayment vehicle in place from day one.

Remember, the worst thing that anyone could do is to financially over-extend themselves. It is essential, therefore, that investors do their sums and anticipate the financial implications, for example, of a softening in rental income or an increase in mortgage repayments, should interest rates go up.