Whether you’re new to buy-to-let (BTL) or a seasoned investor, one of the most important decisions you will have to make is what buy-to-let mortgage to go for. Now, you may already think you know how to get a buy-to-let mortgage, but do you really know how buy-to-let mortgages work? Read this buy-to-let guide on mortgages to see if we can help you understand the market better.
Buy to let mortgages
First and foremost, what is a buy-to-let mortgage? At the basic level, they work in a very similar way to a mortgage on your home (known as a residential mortgage), with the same types of rates, fees and charges. However, they do have a few key differences which are worth being aware of.
Mortgage interest rates
Buy-to-let mortgage rates tend to be higher than those for a mortgage on your own home, as they constitute a higher risk for mortgage providers – whether lenders will be able to make their repayments each month depends not only on the lender, but also the tenants, who will be a largely unknown factor in the equation.
The amount you can borrow in relation to the value of the property (the loan-to value, or LTV) is generally lower for BTL mortgages, so you wouldn’t be able to get such a mortgage with only a 10% deposit. Indeed, the maximum you could hope to borrow is typically around 80% of the property’s value, which means you would need at least a 20% deposit, compared with a residential mortgage where you could borrow 95%.
Fees are generally higher
Not only are buy-to-let mortgages more expensive than residential mortgages when it comes to interest rates, but arrangement fees on buy-to-let mortgages can be a lot higher as well, with percentage-based fees of up to 3.5% of the mortgage amount typically being charged to secure the cheapest fixed or tracker rates.
While interest-only mortgages have largely been phased out of the residential market, you will easily be able to find such a deal with a buy-to-let mortgage. This is because buy-to-let properties can be more easily sold than residential properties, after tenants move out. Landlords tend to choose interest-only over the full repayment option, as the monthly mortgage repayments will be a lot lower, enabling them to maximise cashflow to purchase further properties.
Landlords can claim tax relief on the interest they pay on a buy-to-let mortgage, although this benefit is being restricted over the next few years. So, interest-only mortgages can be more tax efficient than repayment ones as the whole repayment could qualify for this relief, rather than just the interest element of a capital and interest mortgage.
One of the key areas of difference between a buy-to-let mortgage and a mortgage on your home is how affordability is assessed. For a residential mortgage, income from employment, pension, benefits and a myriad of other sources is used to determine whether you can afford the mortgage repayment.
For a buy-to-let mortgage, while income is still used to determine if you will get the mortgage or not, and under what terms, it is usually assessed as a percentage of the mortgage payment – typically at least 125%, but this can be as much as 145% of the mortgage payment. So, if your mortgage payment is £600 per month, you need to be getting rental income of at least £750. Crucially, the ‘rental value’ of your property needs to be verified by the surveyor who conducts the mortgage valuation.
If you opt for one of the lower fixedor tracker rate buy-to-let mortgages, you may find that the lender calculates whether you can afford the payment not on the amount you initially pay, but on the rate you would revert to at the end of the initial period (in some instances they may even use a higher ‘managed rate’ to ensure you can afford the mortgage).
For example, if you’re on a fixed rate of 4.00% for two years, reverting to a variable rate of 6.00%, the lender might conduct their affordability check based on a percentage (again, in all likelihood, at least 125%) of what your payment would be at the higher rate.
Sometimes a lender will allow your personal income to be assessed either using a multiple of what you earn (or receive), or by assessing your finances more holistically in what is known as your ‘ability to pay’. A mortgage that is assessed in this way could be the route to go down if you want to have your buy-to-let mortgage on full repayment, as the monthly repayments on these are likely to be more expensive than on interest-only products.
Finally, a lender may specify that you need a minimum income level to give them some confidence that you have other resources to fall back on, should you have trouble with under-occupancy or rental arrears. Generally, however, you will want to have your buy-to-let deal based on a percentage of your rental income, as this will not affect your ability to get a residential mortgage; if you use the same criteria as for a residential mortgage, you might have a harder time getting a remortgage for your own home.
Harder to get?
Given the stricter buy-to-let lending criteria, you may think that buy-to-let mortgages will be harder to get than residential ones. However, as long as you satisfy all of the provider’s buy-to-let mortgage criteria, there’s no reason why the process shouldn’t be just as smooth (or rough) as residential mortgage processes can be. As long as you’ve done your homework and have all your paperwork ready to go, you can arrange a buy-to-let mortgage in three to six weeks, which is similar to how long a residential deal can take.
Things to watch out for…
There are a few more things you should keep in mind before you dive in.
Your mortgage lender may only assess whether you can afford the monthly mortgage payment, but we all know that the day-to-day costs of letting a property don’t end there. There’s also:
- Letting agent fees, if you use one (a letting agent can really take the burden off you, particularly if you’re a first-time landlord)
- Maintenance costs
- Annual safety checks
- Landlords insurance (to protect the building and any contents)
- Rent insurance (which protects you during periods of un-occupancy or arrears)
- You might even be paying into an investment, such as an ISA, Stocks and Shares ISA or pension, with the hope of repaying your buy-to-let mortgage and owning the property outright at the end of the term
These costs may not be taken into account by the mortgage lender, so make sure that you can afford it all before you proceed.
Living in your rental property
If you change your mind, or your situation changes and you want to live in your buy-to-let property yourself, you will need to change to a residential mortgage. Similarly, most buy-to-let mortgages will have a clause in them that prevents close family members from being your tenants. Luckily, interest rates on residential mortgages tend to be lower, so you will likely be better off switching even if your BTL provider agrees to let you stay in the property or charges high early repayment charges.
Most buy to let mortgage activity is not regulated by the Financial Conduct Authority (FCA). However advising on, arranging, lending and administering “Consumer buy-to-let mortgages” is subject to the Mortgage Credit Directive Order 2015. As such, the FCA is responsible for registering, supervising and taking action where necessary against firms carrying out these activities. Consumer buy to let is where the property is to be let to a close family member. These are regarded as regulated mortgages.
Buy-to-let mortgage criteria
Whereas a mortgage on your home will only be on one property, a buy-to-let mortgage can be on several properties. It’s worth checking the following before proceeding with your application:
- Minimum valuation. Some lenders will only lend on properties valued above a certain level. Whilst this is usually a nominal amount of £40,000 to £50,000 (we’re sure you’d agree that there aren’t many properties around at those prices!), some stipulate minimum valuations at the far more plausible level of £100,000 plus.
- Property type. If the property you own is of unusual construction (some forms of concrete ex-local authority houses, for example) you may already be well versed in which lenders will be happy to lend. Some landlords with new build flats could even find it difficult to secure buy-to-let mortgages if they’re deemed to be over-valued.
- Some lenders will restrict the number of properties you can have on one buy-to-let mortgage and/or the maximum amount that they will lend. This may mean that you can’t put in multiple applications with the same lender either, as you may only be able to have a certain number of properties mortgaged with the same lender, or even the same parent group. Note that while you can have as many buy-to-let mortgages as you can afford, recent regulatory changes mean that those with more than three buy-to-let properties will be treated as ‘portfolio landlords’. This means that all of their rental properties will be taken into account when applying for a new loan – so if one of your rented homes isn’t doing well, you will likely be offered a less attractive deal.
- Your age can play a part in whether you can have a particular buy-to-let mortgage, or how long the term can be over. Although not all do this, many lenders will limit the mortgage term to when you reach the age of anywhere between 70 and 90. Be aware of this if you’re intending for a buy-to-let property to augment your income in retirement.
Buy-to-let (BTL) properties can make you money in two ways:
- Capital growth (the value of your property going up)
- Rental income
However, as much as you can make money, you can also lose it if:
- Property prices go down – you lose money on the value of the flat or house
- You have trouble finding tenants to fill the property, or getting the level of rent you need to break even.
Even so, at present, with the property market improving and house prices rising, it may be the time to think about becoming a buy-to-let investor. Just make sure you understand the investment risks associated with a buy-to-let property, and if unsure, seek the advice of an independent financial adviser.
Renting our your home
Some people fall into becoming landlords. For example, you might meet a new partner and move into their property, keeping your own to rent. You may move abroad to work, but want to keep your home in the UK. You might even have had trouble selling your property, and could become an accidental landlord by default.
Whatever the reason, it’s important you make the transition from the property being your home to an investment properly. This includes:
- Telling your mortgage lender. You’d be surprised how many people don’t do this! The mortgage lender needs to give you formal ‘consent to let’. This may, but not always, mean that you are put onto a higher rate of interest. If your payments go up, it may be worth shopping around for a new BTL mortgage. Remember, failure to notify your mortgage lender that you are letting out your property will put you in breach of your mortgage agreement.
- Tell your insurer. Standard buildings and contents insurance will not cover you if the property is let, so you will probably need to arrange specialist landlords insurance instead.
- Speak to a professional letting agent (preferably one that’s a member of the Association of Residential Letting Agents). If you aren’t in a position to be too hands on (or you just don’t want to be!), a letting agent can help with the work of managing your property. They can also help with the process of setting yourself up as a landlord, such as by helping you sort out an Energy Performance Certificate, for instance.
A letting agent should use an approved Tenancy Deposit Protection scheme, and should carry out comprehensive checks on prospective tenants for you.
- Speak to an accountant or tax adviser as there are tax implications for buy-to-let properties which you may not be aware of.
Taxation of buy to let
A buy-to-let investment attracts several different taxes.
From April 2016, Stamp Duty rates for buy-to-let properties increased. These are now set 3% higher than residential mortgage purchases, as follows:
Buy-to-let and second home stamp duty tax bands
home rate (April 2016)
Up to £125,000
£125,001 – £250,000
£250,001 – £925,000
£925,001 – £1.5m
As an example, stamp duty on a buy-to-let property priced at £250,000 will be £10,000, compared with £2,500 for a residential house purchase.
You may also have to pay Income Tax on the rent you receive and Capital Gains Tax when you sell the property. Rental income must be declared on a self-assessment tax return (the amount you pay will be subject to your tax banding). You can currently deduct costs such as mortgage interest and letting agency fees from the rent you receive first, but these tax breaks will be gradually removed over a four-year process, starting in 2017.
And like anything else you own, a buy-to-let property will form part of your estate for Inheritance Tax purposes. Some of these tax issues can be dealt with by buying a property via a company rather than as an individual, so many buy-to-let investors are setting up as companies to run their buy-to-let portfolios. If you are unsure, seek the services of a good accountant (your letting agent may be able to recommend one used to dealing with buy-to-let).