A Guide to Investment Property Financing

Property can be a lucrative investment option for many reasons. As well as adding diversification to your portfolio and receiving various tax benefits, you could benefit from a stable income stream generated through rental payments, and significantly increase your profits thanks to potential capital appreciation.

This is not guaranteed, but property prices have historically risen over time – according to the Land Registry, the average UK house price has gone from £60,000 in 1991 to £250,000 in 2021; a 300% increase in 30 years.

Compared to other assets such as stocks or bonds, the cost of property investments can be a significant barrier to entry. Luckily, you have many options for financing your investment property. These are the most common choices, and their unique pros and cons.

Option 1: Mortgage

You’ll likely be familiar with the traditional mortgage if you’re a homeowner. This is a long-term loan secured against the property, meaning that the lender can repossess it if you don’t make your repayments.

However, for an investment property loan, you’d apply for a commercial mortgage rather than a residential mortgage. This can be used to finance a non-residential property like a shop, office or warehouse. Or, if you wanted to buy a residential property to rent out, you’d apply for a type of commercial mortgage called a buy-to-let mortgage. These products work in the same way as a traditional mortgage but you’ll likely need to pay a larger deposit (usually 25-40%) and interest rates will typically be higher.

That said, a significant benefit of this investment property financing option is that interest rates tend to be lower than the alternatives. Plus, you have price certainty if you choose a fixed-rate mortgage, making budgeting easier as you’ll know the exact cost of your repayments. Other advantages include the long repayment term that allows for smaller monthly payments, and the fact that you will receive a 20% tax credit on your mortgage interest costs which can be offset against your overall tax bill. The tax benefits are greater if you buy the property as a limited company rather than personally – your mortgage interest is fully allowable, reducing your tax bill further.

However, you will need to meet strict eligibility requirements. For example, some lenders may want proof that the rental income will be at least 125-145% of the mortgage repayments. In addition, a traditional mortgage isn’t an ideal investment property loan if you’re looking to make a quick purchase as approval can take time.

Option 2: Bridging Loan

A bridging loan is a short-term option you could consider to finance your investment property. This is designed to “bridge the gap” when you want to buy something, but you’re waiting for the funds to become available from elsewhere (for example, the sale of an existing property or securing long-term financing). Most lenders will allow you to borrow up to 75% of the property value.

There are two types of bridging loan. An open bridging loan has no fixed repayment date and can be repaid whenever your funds become available (though lenders will normally expect this to be within a year), while a closed bridging loan does have a fixed repayment date and is often cheaper as it’s less flexible than an open bridging loan.

Unlike a mortgage, which can take time to secure, you can use a bridging loan to finance an investment property quickly as they can often be secured in a matter of days. The short-term nature of this product also makes it suitable if you’re looking for temporary financing before securing a longer-term solution.

However, interest rates and other fees (such as arrangement fees and valuation fees) will usually be higher compared to mortgages. You also need to consider an exit strategy – as the term is shorter, there’s a higher chance of financial pressure when it’s time to make your repayment.

Option 3: Private Investor Funding

Another investment property financing option you could consider is private investor funding. This involves securing investment from individuals or groups who provide capital in exchange for a share in the property or returns on the rental income.

There’s more potential for flexibility if you choose this route as the repayment terms, interest, and structure of the investment can be negotiated to suit both parties, and as this financing does not take place through a formal lending institution, there may not be strict credit checks. Working with private investors may also allow you to benefit from their skills and expertise in the property sector. For example, they might be able to offer advice, networking opportunities, or additional resources to maximise the return on investment.

A possible downside to this financing option is that depending on the agreement, investors might want to have a say in how the property is managed and/or receive a significant share of the rental income or capital gains.

Option 4: Equity Release

If you’re a homeowner, you can use your own home as collateral thanks to equity release. This allows you to unlock cash tied up in your property without needing to sell or move. This is usually done through a lifetime mortgage where the loan is eventually repaid (with interest) from the sale of the property.

Normally these products come with fixed interest rates so you know exactly how much this financing option will cost. However, interest is usually ‘rolled up’ (the interest will be ‘compounded’ – meaning it’s calculated based on the sum of the original loan, plus the interest) so the amount you owe can grow rapidly.

Usually equity release isn’t available to homeowners under the age of 55 and the maximum equity release permitted will depend on your age (the older you are, the higher the maximum equity release can be). Also bear in mind that equity release can affect your eligibility for means-tested state benefits such as Pension Credit if the income you gain puts you above the benefits threshold.

Choosing the Right Investment Property Financing Option

The various investment property financing options have very different pros and cons. Some key factors you should consider before making your decision include:

• Interest rates and overall cost
• Loan-to-value (LTV) ratio and deposit requirements
• Speed and flexibility of funding
• Eligibility criteria and your creditworthiness
• Repayment structure and term length
• Risk tolerance and financial security
• Fees and additional costs

Here at Alesco, we have years of experience identifying UK investment properties offering high rental returns and strong capital growth, and boasting low entry price points. We can support you in securing an affordable property that meets your investment goals and we will be with you every step of the way throughout the purchasing process.

Find out more about investing in property with Alesco here.