Guide to buy-to-let mortgages
- You’ll need a buy-to-let mortgage if you want to borrow to buy a rental property, or a buy-to-let remortgage if your residential mortgage deal ends and you want to rent out your home
- Although how much you can borrow usually depends on the rental income, you may also need a separate income and there may be other restrictions
- Gocompare.com introduces you to London & Country whose fee-free, expert advisers can help you find the right buy-to-let mortgage - request a call back or phone 0800-073-1959
Despite the ups and downs of the property market, investing in housing is traditionally considered to offer decent returns in the longer term.
Unless you’re a cash buyer, you’ll probably need a buy-to-let mortgage in order to become a landlord.
There are plenty of things to consider and calculations to make before diving in and beginning to build your property empire.
Who needs a buy-to-let mortgage?
If you want a mortgage to buy a property to rent out to tenants, you need a buy-to-let mortgage.
Don’t be tempted to try to save money by attempting to get a residential mortgage instead - even if your application were successful (which is unlikely) you’d be committing mortgage fraud and breaking the terms and conditions.
That could have dire repercussions, including the lender demanding that you repay immediately and in full.
Consent to let on a residential mortgage
There is one exception to this - if you want to move house and let out your former home, some residential mortgage lenders will grant you consent to let.
Consent to let gives you permission to legally rent out your property, but usually only until the end of your current mortgage deal. After that you’ll be asked to take out a buy-to-let mortgage if you want to keep renting out your property.
There’s usually a fee for consent to let and sometimes your interest rate will be increased, too.
People who’ve got into buy-to-let this way are often called ‘accidental landlords’.
Types of buy-to-let mortgage
Remember, variable rates could change at any time, so if you’ve budgeted to make sure your rental income covers the mortgage payments, you may need to leave a particularly wide margin with a variable mortgage to make sure an interest rise doesn’t leave you struggling.
Standard variable rate (SVR)
If you want to repay your mortgage early or change products before the end of the initial term, you’re likely to incur early repayment charges.
After the initial term of your tracker, discounted or fixed mortgage ends you’ll be moved onto your lender’s standard variable rate (SVR) which, as the name suggests, can go up or down.
SVRs for buy-to-let mortgages tend to be far higher than for residential mortgages, so you might want to think about remortgaging to a new deal well in advance of your fixed or tracker rate ending.
Holiday let mortgages
If you want to let out a property as a holiday home you can’t usually take out a standard buy-to-let mortgage on it.
Instead you’ll need a specific holiday home mortgage which - unlike buy-to-let mortgages - often requires you to have a high minimum income of your own.
Interest rate and fees
Interest rates and fees for buy-to-let mortgages can be far steeper than on residential products, despite the fact you generally need a more substantial deposit.
Arrangement fees can be thousands of pounds, so make sure you factor this in when calculating whether buy-to-let is for you.
Interest only or repayment?
It’s extremely difficult to secure an interest-only residential mortgage, but with buy-to-let interest-only is more common.
You’ll usually have to provide the lender with an explanation of how you expect to repay the mortgage, but sale of the rental property is normally an acceptable strategy.
In fact, it can actually be more cost-effective to take an interest-only mortgage for buy-to-let because landlords get tax relief on their mortgage interest payments.
If you have an interest-only mortgage, the amount of interest paid during the tax year is easier to calculate as it’s simply the amount you paid on your mortgage.
For instance, if your rental income is £8,000 for the year and you pay £2,000 on an interest-only mortgage, you’ll pay tax on the £6,000 profit.
But if you have a repayment mortgage, the repayments will reduce the interest paid a little each month, so in a tax year the landlord might only pay £1,800 in the example above.
Did you know...?
- Many lenders will want the rental income to cover at least 125% of the mortgage each month
That means the landlord would be taxed on a £6,200 profit, leaving them with less after tax.
Be warned that this situation is set to change from 2017.
In the 2015 Autumn Statement, George Osborne announced that landlords will no longer be able to get full tax relief on interest payments due to a tax credit system which will be gradually phased in from April 2017, so that by 2020 all landlords will pay tax on the full rental income and then receive a basic-rate tax credit instead.
This will particularly affect higher-rate taxpayers, but all buy-to-let landlords will be affected by the change, so it’s a good idea to start thinking about how to handle this well in advance.
Saving instead of repaying
Landlords might choose to take an interest-only mortgage, and place the extra rental income into savings.
This can be a clever strategy, so long as you can achieve an after-tax savings interest rate that’s higher than your mortgage interest rate. For instance, if your mortgage rate is 3%, you’d want to place the rest of the income in savings or investments that yield at least 3% AER after tax.
Remember, all sorts of expenses can crop up with rental properties, so it’s wise to accumulate some funds in an easy-access savings account or even a high-interest current account for this purpose.
How much can you borrow with a buy-to-let mortgage?
Loan to value
For most buy-to-let mortgages you’ll need a substantial deposit, with 25% being the minimum in most cases.
Some lenders may offer a higher loan-to-value, but these deals may be thin on the ground - speak to an adviser at London & Country to find out what you might be eligible for.
Buy-to-let mortgages don’t follow the same affordability rules as residential products - instead of the amount you can borrow being based on your salary and expenses, it’ll be based on the rental income your property can achieve.
Typically lenders will want the monthly rental income to cover 125% of the monthly mortgage cost and some lenders will base this on a repayment mortgage amount, even if you’ve taken an interest-only product.
A mortgage adviser can help calculate how much you might be able to borrow by looking at your individual circumstances.
Restrictions on buy-to-let mortgages
Buy-to-let certainly isn’t for everyone and there are a few restrictions that you’ll need to consider.
Although buy-to-let affordability is usually based on rental income, that doesn’t mean your income will be disregarded entirely. Many lenders will ask for a minimum salary to make sure you have something to fall back on to pay the mortgage if your rental business doesn’t go to plan.
If you’ve no previous experience of being a landlord, you may find yourself excluded from some products.
Although some of these lenders may consider you if you’ve rented out your former home on consent to let, others will only be interested if you’ve had a full buy-to-let mortgage in the past.
If you’ve never held a buy-to-let mortgage before, a broker will be able to guide you towards products and lenders that'll accept these circumstances.
Most lenders will ask that the rental income covers more than the cost of the mortgage repayments, with many asking for the rent to be at least 125% of the monthly mortgage payments.
Most lenders impose a maximum number of mortgaged buy-to-let properties you’re allowed to have, which is typically four.
What’s more, some lenders impose restrictions that involve any mortgaged residential properties you may have. For example, they may not allow a buy-to-let mortgage on a property that has a higher value than your residential property.
Regulation of buy-to-let mortgages
In general, buy-to-let mortgages are unregulated, which means they aren’t within the jurisdiction of the Financial Conduct Authority (FCA).
However, if the lender is FCA authorised it’s expected to treat customers fairly and you’ll be able to complain to the Financial Ombudsman if something goes wrong.†
Making buy-to-let pay off
To make a success of buy-to-let, there’s more than just the mortgage to consider. Make sure you take into account the other taxes and expenses you’ll encounter as a landlord.
Your rental income is subject to income tax and the rate you pay will depend on your overall income (including your salary from any other jobs you have).
There are a number of expenses that landlords can set against tax, which most significantly include the interest and fees you pay on your buy-to-let mortgage.
However, in the 2015 Summer Budget, George Osborne announced that this was set to change, with this tax relief being phased out in 2017 and gradually replaced by a tax credit equivalent to basic-rate tax.
This is likely to affect all landlords with a buy-to-let mortgage, but higher and further rate taxpayers will be particularly affected by the changes.
Remember too that if you sell your rental property you’ll probably be subject to capital gains tax.
You’ll have a personal allowance, letting relief and you may also have some tax relief if the property has been your own home at any time, but the calculations for capital gains tax can be complex.
To help calculate your tax and make the most of any allowances and tax relief, you might want to consider employing the services of an independent financial adviser.
In the past, landlords buying property paid the same stamp duty on the purchase as residential buyers, but that's set to change.
From April 2016, landlords will pay an extra 3% stamp duty compared with the rates charged for each tier for residential buyers.
That could be a very significant cost if you’re buying a property to let out and you’ll have to account for this alongside your other fees and costs.
Unless you plan to be a very hands-on landlord, you’ll probably have to pay letting agency fees for at least some services.
There are different levels of agreements, from simply advertising the property and conducting the initial tenant checks, to fully managing the property for the duration of the tenancy.
A fully managed agreement might typically be 10-15% of the rental income plus VAT, with annual fees on top.
Repairs and maintenance
A high-interest current account can be a particularly convenient home for an emergency fund, because you’ll have a debit card to pay any expenses as and when they occur.
Once your initial buy-to-let mortgage deal ends, you’ll be put on the lender’s buy-to-let SVR.
This can be very costly, with these rates usually far exceeding promotional rates or residential SVRs.
When you near the end of your initial buy-to-let mortgage, it’s a good idea to start looking around for a remortgage deal.
You might want to remortgage simply to get a better deal, or if house prices have gone up you might want to take out further borrowing - perhaps to improve your rental property or as a deposit towards another one.
Most lenders will allow you to secure a remortgage deal as much as six months before your current product ends, so contact London and Country on 0800-073-1959 for free advice on mortgages from a wide range of UK providers.
By Derri Dunn