INTEREST-ONLY mortgages may not be the best option for residential borrowers, but advisers often recommend them to buy-to-let investors because of the tax perks.

Landlords can offset the interest they pay on their mortgage against rental income to reduce the amount of tax they pay.

For example, say you receive £10,000 a year in rent but pay £8,000 in mortgage interest, you would only pay tax on £2,000. Interest-only mortgages enable you to maximise this benefit because the level of debt remains the same. If you opted for a repayment mortgage, the amount of interest you pay, and therefore the tax relief you get, reduces as you pay off the capital.

Many landlords expect to sell their property to repay the mortgage debt, but the Financial Services Authority (FSA) is concerned that they do not fully appreciate the risks. An FSA spokesman said: “Bear in mind that if house prices fall you might have to sell your property at a loss, so you could end up in negative equity. You also do not know what the housing market will be like when you need to sell. What happens if you cannot find a buyer but need to repay the mortgage?”

However, some experts think these risks are exaggerated. Ray Boulger at Charcol, a mortgage broker, said: “Buy-to-let investors have to put down a bigger deposit than residential borrowers — the minimum is 15% — so house prices would have to drop by 15% or more over the mortgage term for the borrower to be in negative equity.

“In many instances lenders require a deposit of 20% or even 25%, so borrowers have even greater protection against falling house prices.”

Landlords who are worried about negative equity, can take out a flexible interest-only loan. They can then make over- payments and so repay the capital.

Lenders offering flexible loans include Bristol & West, Mortgage Express, Stroud & Swindon, Scarborough and Coventry building societies. Stroud & Swindon, for example, has a flexible lifetime tracker that is 0.99 points above the base rate, giving a pay rate of 5.74%.

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