Should I re-mortgage my portfolio to pay off my own home?

This is a question we are asked frequently, but there is no “one size fits all” answer to this question. Whether you should re-mortgage an investment property or a portfolio will depend on your personal circumstances and what your investment plan is.

If you’re an investor, you need to understand how to use a mortgage and what the issues are with being too highly leveraged. If you have an understanding of these concepts and how they influence the performance of your investment, you’ll be able to make an informed decision.

How to use a mortgage ?

The use of debt is an interesting concept for investment, on one hand, debt is a valuable tool and can allow you to quickly expand your property portfolio. However, on the other hand, debt creates additional risk.

As an investor, generally, you will want to capitalise on using high levels of debt in the following situations:

  • Low rates: When interest rates are low, at points in the market cycle when there is expansionary credit. You can lock in lower interest rates. In some scenarios, it may well be better for you to lock in at long-term rates even if they are at higher levels if there is a risk of rates climbing quickly throughout the fixed term.
  • Expanding portfolio: If you are looking to expand your portfolio, debt is a useful tool. However, it will reduce your net income as your debt costs are higher. Hopefully, your property will increase in value and will amplify your capital appreciation.
  • Market Growth: When the market is likely to grow in the early part of the market cycle, debt is a good tool to use to fund property purchases
  • Interest rates are tax-deductible: When interest is deductable it can be a highly effective tool for investors because its cost can be used to reduce tax liabilities. Be aware, interest is not fully tax deductable on property in the United Kingdom.
  • Amplify returns: Returns can be amplified with debt because it is the cheapest form of capital, so it can help the investor obtain a greater return from their equity.
re-mortgage

An example of using a mortgage

Let’s compare the potential return for an investor purchasing a property for £400,000 with and without a mortgage.

Let’s assume both investments grow by 5% p.a. after 5 years, the two alternatives will be as follows:

 Scenario 1 (with a mortgage)Scenario 2 (no mortgage)
Purchase Price (£)400,000400,000
Initial Equity100,000400,000
Growth rate5% p.a.5% p.a.
Value after 5 years486,203486,203
Capital Appreciation on the initial investment86,20386,203
Initial Investment100,000400,000
Return on Investment86%21%

Issues with being too highly leveraged

When appropriately used, leverage can be an effective tool for you to increase the return on your investment. The key is to avoid making decisions without proper consideration of your risk. Consider the following:

  • Counting on high levels of capital appreciation: Many real estate investors assume what has happened in the past will happen again. Just because property prices have rapidly increased in the past does not mean they will in the future. If property prices have rapidly increased it is unlikely, they will continue at the same trajectory. Hope for high levels of capital appreciation but do not bank on them. When you plan out your leveraged real estate investments, look at three scenarios: best, worst, and most likely.
  • Ending up with too high a payment: It can seem like a great investment to buy a property with a very low deposit payment. And it is easy to fall into the trap of looking at the numbers and seeing a high return on investment due to a very low cash outlay. The problem arises with the higher payments that come with higher leverage. For instance, if this is a mortgage, you can count on having to make monthly payments, and the more you borrow, the higher the monthly payment. Suppose the market softens or your properties experience higher-than-expected vacancies or rents are not as high as what you expected. In these cases, you could find yourself unable to maintain the higher mortgage payments. If you are unable to make the monthly payments, your investment is in jeopardy.
  • Overpaying for a property because you can finance it: Many investors overpay for a property just because they can afford to purchase a property with very little cash outlay. Do not fall into the trap of paying too much for a property simply because you get a mortgage. Do your research, look at the value of the property in the context of current and expected market trends. Paying too much could result in two issues:
    • When it becomes time to complete, a valuer does not value the property as being worth what you paid. If this happens, you will have to make up the difference
    • Capital appreciation will be minimal or, worse still, non-existent. If the market declines, you will be in serious trouble. Your overpriced property will be a significant drag, and you will not be able to sell it without accepting a loss
  • Cash flow is king: Errors in calculating income or expenses will impact your cash flow. Cashflow is King! If you do not generate enough cash flow each month to pay your expenses, then you will have to top up the payments from your own money.
  • Debt capacity: Debt capacity is something which many people will not give a great deal of consideration, but it should be an important consideration. Essentially, the more debt you have the less additional debt you will be able to take on through future borrowing. Whilst loading up on debt may seem like a good idea, it will also mean that you will be restricted in what you can borrow in the future.
  • Increasing interest rates: Interest rates go down, but they also go up! So, when looking at purchasing property with debt, particularly high levels of debt, you need to consider a situation where rates go up considerably. You need to assess how you can service debt in these situations, as when interest rates increase it is likely because the economy is overheating. So do not count on putting the rent up or having a tenant.
property analysis - re-mortgage

So, if you are looking to release equity from your property portfolio to pay off a mortgage on your own home, these are the factors you need to give consideration to before making any decisions.

Important notice:  Proptech Pioneer and its associated companies seek to provide real estate investors with guides, information and tools, but we cannot guarantee this information to be accurate or perfect.  You use the information at your own risk and accept no liability if you rely on this information.   Proptech Pioneer is not a tax advisor, accountant conveyancer, lawyer, financial advisor or mortgage advisor.  You should seek independent advice from independent professionals before making any investment decision.