I received a delightful email recently from a lady who wrote:-
“I read your blog a couple of years back re the importance of having an unencumbered property and after rethinking my long term strategy I have now achieved this with two properties , one of them being one we converted into 8 flats. This means I was able to retire from my full time business two months ago at the grand age of 50 so once again thank you.” – KM
That makes my heart sing and also shows that when you pick a strategy and ‘go for it’ with all your might amazing things can happen!
Here’s the post:-
Should finances allow, I commonly suggest that investors obtain or keep an unencumbered property (no loan of mortgage secured on it) as quickly as possible as it’s an incredibly powerful tool to have at your disposal and here’s why.
Firstly it’s always there to fall back on; no matter how low lenders reduce LTVs you’ll nearly always be able to raise cash on it in an emergency. You never know when you may need some quick cash and if your portfolio is geared up and lenders move the goal posts you may find yourself unable to lay your hands on some urgently needed cash. This may be for the deal of a lifetime, it may be to help a friend or relative or it may be for an unexpected bill!
Secondly, having an unencumbered property enables you to strike all sorts of deals with partners and lenders. You can create the equivalent of a revolving loan or drawdown facility, you can use it as collateral for a business loan or a joint venture for example.
However the most significant reason for having an unencumbered property is it enables No Money Down financing perfectly legitimately. Let me demonstrate…
You buy a property that you intend to refurbish for 100k – you’d typically have to put in say 30k deposit plus costs of works and purchase and finance costs of say 30k. So you have to find sixty grand.
Now imagine you have a property worth 100k that’s unencumbered.
You could bridge across the two properties and get all of your purchase money and costs and make it a true and legitimate No Money Down deal.
Once the property is sold on you repay the bridging loan in full returning to an unencumbered property plus profits (hopefully!) You could remortgage the new property or even remortgage the original unencumbered property and then leave the new one unencumbered and so on. There are many factors that come into play here depending upon your strategy but hopefully you see the point.
It is true that you could remortgage the unencumbered property on a buy to let mortgage in the first place and raise the cash that way and pay a lot less interest for it but you’re also paying for it whether you use it or not. If you leave it unencumbered then you are only paying for it whenever you need it, rather than obtaining the money on a mortgage and being tempted to use it unnecessarily.
The ideal of course would be the equivalent of an offset mortgage but unfortunately these aren’t currently available for buy to let.
You also can’t do anything else with it as the lender has first charge so you have no flexibility to use it for other purposes or in an emergency. In addition you may find that you have to jump through a lot of hoops to get a buy to let mortgage but would easily qualify for the much more relaxed lending criteria associated with bridging loans. Not to mention it takes a lot longer to arrange a mortgage than it does a bridging loan.
So how do you get an unencumbered property if you don’t have one now?
The obvious way is to either save up your cash or do a couple of deals and end up with an unencumbered property but for many investors this isn’t realistic or even possible. If you already have a portfolio of properties there are a few relatively easy ways to achieve this however.
Firstly, take a look at your existing gearing levels and consider if you could remortgage a couple of properties to leave another one unencumbered. Your overall debt remains the same (albeit considering any fees payable, your existing interest rates and the new interest rates) and you now have an unencumbered property.
Another way is to pick one property and pay off the mortgage as quickly as possible.
If any of your buy to let mortgages are on a repayment basis why not change them to interest only and the selected one to repayment? Then make additional payments to whatever level you can afford. You do need to read your mortgage contract however as many mortgages have a maximum repayment in any one year, typically 10%, but just pop that money into a savings account and pay it off at the end of the product term instead.
If you have a part time job or run a small internet business for example then give that income a purpose and throw it all at this one mortgage. Much like paying off your credit cards it will start to snowball and you will soon see the mortgage come down to zero.
I once saw someone do this by creating a huge poster of a house; they drew the house out of small squares that each represented £100. As they paid off each £100 they coloured in another square! Childish? Maybe but the speed with which they paid off an entire mortgage was astonishing so who cares!
Why not allocate one of your other rents to this property and throw all the spare cashflow at it? If you’re benefiting from some of the very low base rate trackers right now you have the perfect opportunity to do this.
Another great property to do this with is a property that’s not easily mortgageable; I often speak to clients who have a part commercial part residential property on one freehold. These aren’t that easy to finance in the current market so I often suggest that instead of refinancing it they simply leave it unencumbered and use it as I’ve suggested; it will be perfectly acceptable for bridging security. I’ve talked myself out of doing loads of mortgages this way!
Which property should you pick?
Well assuming that all other factors are equal, the property that has the lowest debt with the highest value – for example which of these three properties would you pick?
A. £100,000 value £65,000 mortgage
B. £55,000 value £30,000 mortgage
C. £250,000 value £150,000 mortgage
I would suggest property A.
The loan to value is actually the highest on this property but it’s got a smaller mortgage than property C thus you can pay it off much quicker. However the value is almost double that of B even though that mortgage could be paid off quicker.
Not all investors are the same and if a client wishes to reduce their debts or not increase their gearing we can help them make the right decision on how to do this and give them the most options for the future.