A guide to buy-to-let mortgages
Buying a property to rent out can seem like a great way to make easy money and save for future investments. While this can sometimes be the case, there are also huge risks involved that you should be aware of. When you buy a property for the purpose of renting it out, you will need a buy-to-let mortgage.
While similar to standard residential mortgages, there are some fundamental differences. This guide will give you all the information you need about buy-to-let mortgages and will help you work out if this kind of investment is right for you.
In This Guide:
- What is different about a buy-to-let mortgage?
- What should one consider when getting a buy to let mortgage?
- How big a loan can you get?
- Who can get a buy-to-let mortgage?
- What happens at the end of the mortgage?
- How to find the best deal
What is different about a buy-to-let mortgage?
If you plan to rent out your home, you need a buy-to-let mortgage. You can only get a standard residential mortgage if you plan to live in the property yourself. There are some key differences between buy-to-let and ordinary mortgages that could potentially make it more difficult to buy a property for rental purposes.
Mortgage providers see buy-to-let mortgages as higher risk than residential mortgages. This is because landlords often face problems with rent collection, and it is unlikely that your property will constantly be occupied.
Because of the higher risk involved you will need to pay a larger deposit for a buy-to-let mortgage. This is usually a minimum of 25% of the total value of the property, although this can vary depending on the lender and type of mortgage. You can sometimes pay a minimum deposit of 20% for a buy-to-let mortgage, although some of the best mortgage rates available require a deposit as high as 40%. Other fees tend to be higher too when taking out buy-to-let mortgages. Arrangement fees can be as high as 3.5% of the property's value.
Most buy-to-let mortgages are interest-only, compared to residential mortgages which are usually capital and interest loans. This means that landlords only pay monthly interest payments, rather than repayments on the loan itself. This usually results in lower monthly payments for buy-to-let mortgages. However, the mortgage must be repaid in full at the end of the term. Most landlords will pay for this by selling the property, although if house prices have fallen since the time you bought the property then you will struggle to repay the mortgage. You should make sure you have enough savings to cover these circumstances.
What should one consider when getting a buy to let mortgage?
The monthly interest payments on a buy-to-let mortgage depend on various factors. These include the size of your initial loan, the rental value of your property and your own financial situation. However, it will also heavily depend on what type of loan you take out, be it a fixed rate or variable rate mortgage. There are advantages and disadvantages to all types of mortgages.
A fixed rate mortgage deal will usually last between two and five years. If you choose this type of mortgage, your monthly interest payments will stay the same for the full term. This will give you the security of knowing exactly how much you will have to pay each month, and you can pass this on to your tenants by guaranteeing their rent won't rise. However, the rates are usually set slightly higher than variable rate mortgages, and you won't benefit from any falls in the interest rate. Once your fixed rate period is over, you will be automatically rolled on to your provider's standard variable rate. These rates are usually some of the most expensive, so you should start looking for a new deal before the end of your term.
Standard Variable Rate
These mortgages are usually your lender's default plan and is what you will normally be moved onto once your other deals expire. They are usually some of the most expensive mortgage deals on offer, with the highest interest rates, so if you are on an SVR it is advisable to find a better deal. The rate can also change at any time at the whim of your lender. One of the only advantages of an SVR is that you are free to find a better deal without incurring any exit fees.
A tracker mortgage has variable rates, meaning your monthly interest payments could go either up or down. These mortgages work by setting the interest rate at a certain level above the Bank of England's base rate. This means that if the Bank of England raise their interest rates, you will be hit with higher monthly payments. But on the other hand, you will benefit from lower bills if there are any falls in the Bank of England's base rate.
These mortgages are set at a fixed rate below your lender's SVR. For example, if the SVR is set at 5% and your discounted rate is fixed at -1%, you will be paying at a 4% interest rate. However, the discounted rate will move in line with the SVR, so will be vulnerable to the same rises. Also, the discounted rate only lasts for a certain amount of time, typically around 2 years. After this deal has expired, you will be moved back up to the SVR.
It would be foolish to think that your monthly interest payments are the only costs you will incur when becoming a landlord. There are many added costs involved that can make your investment seem a lot less lucrative. You need to include these in your budget when considering taking out a buy-to-let mortgage.
Letting Agent Fees
If you use a letting agent or estate agent to manage your property, you will have to pay them letting agent fees. Their services will vary, but can include carrying out credit checks on tenants, writing contracts and chasing unpaid rent. They can also pay towards health and safety checks on your property, which you must do to ensure the home is safe and up to living standards. Typical charges for ongoing management of your property can be between 10% to 17% of your monthly rental income. If you only require a one-off letting service, you would normally be charged around a months rent.
Also known as buy-to-let insurance, this provides cover for property, it's contents and landlord liability.
Buildings insurance is required by most mortgage providers and will cover your property in the event of damage or fire. Contents insurance is not mandatory but will cover any existing furniture you have in the property, including carpets and curtains. You do not have to insure the contents belonging to your tenants - that is their responsibility. Landlord liability will cover you if any tenants or visitor dies or is injured on your property. This is also not mandatory in most cases, but some areas of the UK do require you to have landlord liability, especially if you're renting to students.
Any rent you receive from your tenants is classed as income, and therefore you are obliged to pay income tax on it. The level of tax you pay is dependent on your tax band, so could either be 20%, 40% or 45%. Currently, you can reduce the amount of income tax you pay by offsetting your rental income against other expenses. These include most letting agent fees, council tax and general maintenance of the property. However, the government plans to phase out these tax reliefs by 2020.
Capital Gains Tax
You are obliged to pay Capital Gains Tax if you sell any asset to make a profit. This applies to your buy-to-let property too, and the rate you pay is even higher than other assets. Depending on your tax bracket, you will either be charged 18% or 28% CGT. Once you sell your property and your profit is above £11,700 you must pay CGT. However, if you own your property with a partner you can combine your allowances to increase the threshold to £23,400. You must declare any profit you make on the sale of your property on your Self Assessment tax return at the end of the tax year.
This is a tax put on any transaction involving the sale of property or land. You will have to pay an extra 3% on top of the standard stamp duty tax when purchasing any buy-to-let property above £40,000.
As the owner of the property, the responsibility of any repairs or building costs fall on you, not your tenants. This includes fixing any problems with the heating or water supply, or any existing appliances that break down naturally. You will be surprised how often you will need to cover the cost of these repairs, so make sure you have enough money put aside to deal with any problems.
Missed / Late payment
If you own a buy-to-let property for 20 years, it is unlikely that it will be occupied for the whole time. During your periods without tenants, or when your tenants are late paying their rent, the burden will fall on you to pay your monthly interest payments. Make sure you have enough savings to cover these periods. Any missed mortgage payments could result in the repossession of your property.
How big a loan can you get?
The amount you can borrow depends on how much rent you can realistically expect for your property. Most lenders will typically require you to receive 125% of your monthly interest payments in rental income but can sometimes be as high as 145%.
You can estimate how much rent you can charge by researching similar properties in your area, but your lender will also require verification of your property's rental value from a surveyor. If your provider requires your rental value to be 125% of your interest payments, then you will need to charge your tenants at least £750 a month if your monthly interest payments are £600. This means that the more you can charge in rent, the higher the loan you should be eligible for.
As with all mortgages, a buy-to-let mortgage will have a loan-to-value ratio. This is calculated by the size of your loan as a proportion of the total value of the property. The remainder is made up by your deposit. For example, if your property is valued at £200,000 and your mortgage is £180,000, your LTV ratio would be 90% and you would pay a deposit of £20,000.
Who can get a buy-to-let mortgage?
Applying for a buy-to-let mortgage is not as easy as getting a standard residential mortgage. If you want to invest in property and become a landlord, but don't enough capital to buy a property outright then you will need a buy-to-let mortgage. But before you dive in, there are certain criteria that you must meet in order to be eligible for one.
Firstly, you must already own a home yourself, either outright or with an existing mortgage. Your lender will then assess your financial situation, much like for all mortgage applications. You will be much more likely to get a better deal if you have a good credit rating and haven't racked up large levels of debt either now or in the past, such as on your credit card. You will also much more likely find a lender who will provide you a mortgage if your salary is over a certain amount. Most lenders expect landlords to be earning at least £25,000 a year.
You will also find it difficult to secure a buy-to-let mortgage if you're too old. Most lenders set upper age limits, usually at 70 or 75 years old. However, this doesn't mean that a 65-year-old can easily walk into a mortgage provider and take out a buy-to-let mortgage. The upper age limit refers to the age you will be at the end of your mortgage term. As most mortgages last for 25 years, you would normally need to be 45 years old or younger to be confident of securing a loan. Not all lenders have upper age limits however, and some can be as high as 90 years old.
What happens at the end of the mortgage?
Once your interest-only mortgage deal ends, you will still be expected to pay off the cost of the property at the time you bought it. Most people do this by selling the property. This is where most landlords make their profit, although it is not always so simple. If house prices have fallen since you purchased the property, and the current value of the home is lower than when you bought it, you will make a loss. You will be expected to cover the remainder with your own money.
How to find the best deal
With so many different mortgage providers and types of buy-to-let mortgages available, sifting through them to find the best mortgage deal can be an arduous task. Use our online mortgage comparison tool to help you find the right offer quickly. Just enter a few personal details and the type of property you are searching for and in what area. It will do the bulk of the work for you and you can see a list of the best and cheapest mortgage options available in a matter of minutes. Make sure to factor in any additional costs such as taxes, insurance and letting agent fees so you don't end up paying more than you expected.