Should landlords pay down debt?

Historically, many landlords have grown their portfolios by extracting equity from their existing portfolio to reinvest this money in new properties, growing the pot. At its core, reinvesting has worked well when interest rates have been low and outpaced by rental and capital growth. But, with landlord’s profits squeezed by higher interest rates, is it now time to switch strategy and pay down debt instead?

Here, we take the example of an existing investor with a limited company holding a £1m property portfolio at a 60% LTV and who has £100k in the bank. Their three options are:

1. Re-mortgage their portfolio and leave the cash in a savings account

Based on a mortgage rate of 4.84% on a £600k loan, this investor could see their annual mortgage payments rise by £19,860, or 216%, when they approach the end of their 2-year fix. They’ll likely be paying £29,040 in mortgage interest from 2023, leaving the limited company with a post-tax profit of around £9,780.

Meanwhile, if they were to keep their £100k in a 2-year fixed rate ISA at a rate of 3.83%, they would earn interest of £3,830 in year one.

Overall, the combination of rental profits and interest from savings would leave the company with a profit of £13,610 during the first year.

2. Pay down debt

If they were to use their £100k cash savings to reduce their mortgage debt to £500k, their mortgage payments would fall to £24,200, saving the company £4,840 or 17%, each year compared to the first strategy.

Even though they would no longer be earning any tax-free interest on their cash savings, since the mortgage rate exceeds the cash ISA rate, the investor would be £1,010 better off each year by paying down their mortgage, which equates to £2,020 over the two-year fix. After tax, this would leave them with a profit of £13,740 a year.

3. Use the £100k cash to purchase an additional buy-to-let

The third option involves maximising leverage by using the £100k savings as a deposit to purchase a £400k buy-to-let at a 75% LTV. Based on the average 6% gross yield, this property would generate an additional £24k a year in rental income. Once mortgage costs (£14,665), running costs and tax are deducted, this would leave an annual post-tax profit of £1,535, assuming the property was held in the limited company structure.

Overall, based on a 6% average yield across the entire portfolio and 0% house price growth, this strategy would make around £11,310 per year in post-tax profits for a limited company. While capital growth may boost these returns further in the long-term, a landlord would have to find a property with a gross yield of more than 7% to be better off than investing in an ISA at today’s rates. However, if an investor were able to achieve a gross yield of 8% on their new buy-to-let, this would turn a total annual profit for the entire portfolio of £15,780, making it the most profitable option.

Yet again, this analysis highlights the impact higher yields can have. Generally, investors in lower yielding parts of the country will be better off paying down their debt. However, in higher yielding areas, investors can still profit from growing their portfolios.

Based on the example above, there are 67 out of 330 local authorities in England and Wales where the average investor could make bigger returns by using their savings to fund a 25% deposit on an additional buy-to-let, rather than paying down debt on their existing mortgage. 69% of these areas are in the North of England.