If you want to buy a property and rent it out rather than live in it yourself the chances are, you’ll need a mortgage. And it’s a specific type of mortgage that you’ll need, called a ‘buy to let’ mortgage. Here’s what you need to know about them.
The term Buy to let (BTL) refers to buying a property for investment purposes instead of your own personal use. In other words, you let it out to a tenant and receive an income through the rent received. Over time you should also see an increase in equity if the property increases in value.
Why purchase a buy to let property?
Over the years UK property, despite the odd market down-turn has proven to be a sound investment. A report from the Nationwide Building Society shows the cost of an average home in the UK was around £54,000 in 1991. Over 24 years house prices increased by almost 260 percent with the average house price in 2015 standing at £193,000. There certainly seems to be truth in the old saying “your money is safe in bricks and mortar!”
Many property investors like the fact that property is a very tangible asset that can be improved through modernisation and extension and a corresponding increase in value often results from undertaking this type of work.
Another great thing about owning a buy to let is that you can receive a monthly rental income from your property assuming it is tenanted.
Why do I need a buy to let mortgage?
A buy to let mortgage is a specific type of mortgage for purchasing investment property. It’s a loan that is secured against the house you are buying in the same way as a mortgage you would take out to buy your own home – which is called a residential mortgage. However, a buy to let mortgage differs a little in the way a bank decides whether it is affordable for you.
Which buy to let mortgage is right for me?
There are a whole host of different mortgage deals available when it comes to buy to let mortgages and you’ll see some great headline interest rates. But before you jump in and apply for one it’s important to understand what a lender’s criteria is. Every bank and building society will have their own unique set of criteria points and ideally you want to know whether you will be eligible for a mortgage with them before you apply. Otherwise you could spend a lot of time completing an application and having unnecessary credit checks only to be rejected and have to start the process again with another mortgage lender.
Seek professional advice
You may well be wondering how you can find out if you fit a mortgage lenders profile. Well, you’ve got two options really. Option one is to do a lot of web surfing to gather the information yourself and then speak to the specific lender you want to apply to and try to clarify that you’ll be eligible. Option two is to get professional advice from a buy to let mortgage adviser. With their expert knowledge of the market they’ll be able to guide you through the process and help you navigate any obstacles. They’ll also rule out any lenders that won’t be a good fit and recommend the best deal based on your individual circumstances. They’ll also submit your mortgage application on your behalf and be your single point of contact, keeping you updated on progress as your house purchase progresses.
Repayment or Interest Only?
With a repayment mortgage you pay back some of the initial loan with every monthly you make. This is the type of mortgage most people take out to buy their own home.
When it comes to buy to let mortgages most people go for interest only. This means the monthly payments will only cover the interest and at the end of your mortgage term you’ll still need to pay off the original debt. As property prices generally rise over the long run, buy to let investors will often sell the property at the end of the term and pay off the loan, keeping any profits realised from an increase in value.
By taking an interest only mortgage the monthly payments are significantly lower than with a repayment mortgage. This enables you to pocket any additional rent after you’ve paid your mortgage each month. In this way your buy to let can become an additional source of income for you.
What are the costs of buy to let?
- Purchasing costs
Just like buying your own home there are associated costs when you purchase a buy to let.
You’ll need to put down a minimum of 20% deposit for a buy to let and the best interest rates are available when you put down at least a 25% deposit. This is considerably more than for a residential mortgage where you need as little as 5% deposit. So as you can see you will need a significant pot of money to get started in buy to let.
- Lender fees
Many but to let mortgage deals will come with a lender arrangement fee. These are more common than with residential mortgages and they are typically higher too.
- Solicitor’s fees
You’ll need to pay for a solicitor to handle the legal side of your property purchase.
- Stamp Duty Land Tax
You’ll need to pay stamp duty on the purchase price and if you already own your own home you’ll have to pay a higher rate of stamp duty as your buy to let will be considered an additional property. The governments stamp duty calculator can help you figure out how much you’ll need to pay.
Costs of owning the property
Here are some other costs of owning a buy to let.
You may need to undertake a scheme of improvements in order to bring the property up to a lettable standard. This includes making it safe from a legal standpoint while also making it look attractive to prospective tenants.
- Mortgage payments
Each month you’ll need to keep up your mortgage payments. These should be comfortably covered by the rent you receive from the property.
The bank will insist that you have buildings insurance and it is also a good idea to take out landlords insurance which can cover things like malicious damage to your property and legal expenses if you have disputes with your tenants.
- Letting agents
Many landlords prefer to employ the services of a letting agent. They can find a suitable tenant and handle interviews and reference checking. They can also manage your property on an ongoing basis arranging routine inspections and maintenance and repairs if you don’t want to handle these directly.
- Property Maintenance
You’ll need to pay for any repairs and maintenance on your property. This could be plumbing and heating emergencies, electrical issues or just upkeep due to general wear and tear.
Unfortunately, the tax man will want his cut of any profits you make from your buy to let property. You’ll need to pay income tax at basic or higher rate depending on your tax status. You may also be liable for capital gains tax if you realise a profit when you sell the property.
- Tax Offsetting
It’s worth mentioning that there are ways to reduce the amount of tax you pay on your rental property by claiming tax relief for things like:
- The interest you pay on your mortgage
- Maintenance costs
- Buildings and contents insurance
- Letting agent fees
- Utility bills
There have been a lot of changes to the taxation of buy to let properties recently so it is vitally important to speak to an independent tax adviser to help you understand what tax you will need to pay and any pitfalls to be aware of.
Who can get a buy to let mortgage?
As mentioned earlier, every lender has a different set of criteria for assessing if you’re a safe bet. But ultimately, they want to know that you can afford it and will be able to maintain your mortgage payments. Among other things they will base their decision on the following:
- Rental income
First, a lender will look at how much rent you are likely to receive from the property. They want to see that the monthly rent will cover the monthly mortgage payment. But they’ll want even more reassurance than that. All lenders will then apply a stress test to get an idea of how well you can keep up your mortgage repayments in the future if interest rates were to rise. Generally, they want to see that the monthly rent you receive from the property will cover your mortgage repayment and a bit extra to give you a buffer. If you are a basic rate tax payer they will usually want to see the rent cover 125% of the mortgage payment. If you are a higher rate tax payer this rises to 145%. They’ll also base this calculation on an assumed future interest rate of 5.5 percent.
- Credit rating
Your ability to manage your credit commitments will play an important part of the decision making process. If you’ve had late loan payments, defaults or any other blips on your credit report it could affect how much you can borrow.
The majority of buy to let lenders will want to see that you have some form of income aside from rental property income. This gives them reassurance that you will be able to keep up your mortgage commitments should you experience periods where the property is untenanted. Many will want you to earn a minimum of £25,000 per year. Others won’t stipulate, as long as they can see that you earn an income.
- Size of deposit
A bigger deposit equals a lower loan to value. This is important, as the less a bank is lending you as a percentage of the property price the more comfortable they will feel, as it represents less risk for them. This may also mean you get a better interest rate.
- Potential buy to let problems
Although the UK property market has historically performed very well as an investment vehicle nothing is guaranteed and you could lose money investing in buy to let.
- Empty property
There may be periods when your property is untenanted. If this is the case you won’t be making any money out of your buy to let but you’ll still need to keep up your mortgage payments and any insurance premiums.
- Property repairs
Over time things will need replacing as they wear out. Replacing big items like cookers and boilers can represent a significant outlay that will put a dent in your profits.
- Problem Tenants
There’s always a possibility you could get a bad tenant who may damage your property, steals fixtures and fittings or refuse to pay their rent. If this happens you could find yourself out of pocket unless you have adequate landlord insurance in place.
- Interest rates rises
If mortgage rates go North it could increase your monthly mortgage payments unless you have a fixed rate deal. Again, this would see your profits diminish.
- House price crash
If property prices go down your buy to let may be worth less than what you paid for it. If you need to sell it you could find yourself in negative equity. If you took out a mortgage to buy it and the property is worth less than the loan you may need to find additional money to repay the original debt. While this is unlikely due to lenders not going below 80% LTV it something that needs to be considered as a worst case scenario.
Is buy to let right for you?
As with any investment, careful consideration is needed before you purchase a buy to let. Even more so perhaps than with other investments because you are providing a home for somebody and you need to ensure that you are providing an adequate standard of accommodation and that you are complying with the law. You also need to be aware of the tax obligations of owning a buy to let and I strongly recommend you get advice from an independent tax adviser and a solicitor before jumping in.