When you buy a property as an investment, you won’t be allowed to fund your purchase with a normal residential mortgage. Instead, you’ll need to apply for a specialist buy-to-let mortgage. The good news is that there are lots of deals out there, whether you’re a first-time landlord, an ‘accidental’ landlord, or an experienced investor. The bad news, however, is that the rules around buy-to-let mortgages can be a bit of a minefield.
Buy-to-let is a British phrase referring to the purchase of a property specifically to let out, i.e. to rent it out. A buy-to-let mortgage is a mortgage loan specifically designed for this purpose. Buy-to-let properties are usually residential but the term also encompasses student property investments and hotel room investments.
Buy-to-let mortgages are mortgage arrangements in which an investor borrows money to purchase property in the private rented sector in order to let it out to tenants. Buy-to-let mortgages have been on offer in the UK since 1996.
Lenders calculate how much they are willing to lend using a different formula than for an owner-occupied property. They tend to look at the expected monthly rental income to determine the maximum loan available. Depending on the lender, borrowers might also be allowed to include their own personal income in the calculation of the maximum amount that they can borrow. First-time landlords might also be required to have a separate annual income of at least £25,000. For an owner-occupied property, the calculation is typically a multiple of the owner’s annual income.
The most common type of buy-to-let mortgage is an interest only option. The interest rate on the mortgage can be fixed or variable. Fixed rates means that the payments would not fluctuate, and variable rates means that the payments may go up or down in line with the Bank of England base rate. The interest rates and fees that are offered on Buy-to-let mortgages are, on average, slightly higher than those for an owner-occupied mortgage. This is due to the perception amongst banks and other lending institutions that Buy-to-let mortgages represent a greater risk than residential owner-occupier mortgages.
Many people may not be able to qualify for a buy-to-let mortgage. Criteria for acceptance can include deposit amounts, credit rating, and more. In the late 1990s and during the early part of the 21st century, this type of investment became popular and helped drive house prices dramatically upwards.
How do buy-to-let mortgages work? The vast majority of buy-to-let mortgages are provided on an interest-only basis. This means that, for each month of the mortgage term, you’ll only need to pay the interest on the loan, and none of the capital. While this can be good news in the short term as your outgoings will be less each month, it’s imperative that you have a plan in place to either pay off the full loan or to refinance at the end of your mortgage term.
Buy-to-let mortgage rates have dropped considerably in recent years. In November 2018, the average fixed-rate buy-to-let mortgage had an interest rate of 3.25%, down from 4.38% five years earlier, according to data from Moneyfacts. Variable-rate deals followed a similar pattern, with rates dropping from 4.28% to 3.22% between 2013 and 2018.
How much deposit do I need for a buy-to-let mortgage? To get a mortgage on an investment property, you’ll usually need a deposit of 25% of the value of the home. And as with standard residential mortgages, the bigger the deposit you put down, the better the rate you’ll be able to get. The very best buy-to-let deals are usually only available to investors with deposits of 50% and above. When assessing your affordability, lenders will consider your current portfolio and any previous history of obtaining and paying off buy-to-let finance.
Cuts to mortgage interest tax relief and wear and tear allowance have resulted in some landlords setting up company structures for their buy-to-let portfolios. Buy-to-let mortgages held by companies make up a relatively small percentage of the market at present. They are on the rise – in fact the number of company mortgages on the market tripled in the two years from April 2016. Moving to a company structure isn’t the best move for everyone, as the interest rates on these deals tend to be significantly higher than those available to individual borrowers. Research in 2018 found that the initial rate on an equivalent fixed-rate mortgage was 1.3% higher for companies than for individuals.
While headline rates can be attractive, it’s especially important to look beyond the initial rate when choosing a buy-to-let mortgage. That’s because these products have traditionally come with higher up-front fees than traditional mortgages. If you take out one of the market-leading deals, you might need to pay as much as £2,000 up front! While some lenders are beginning to offer cashback incentives and reduced fees, these offers make up a relatively small proportion of the buy-to-let market.
There are plenty of enticing mortgage offers out there for landlords, but you’ll need to prepare yourself for very strict affordability tests. That’s because in recent years, the Bank of England has looked to cool down what it considered to be an overheating buy-to-let market by imposing tougher lending restrictions. As part of their affordability assessments, lenders use interest cover ratios to calculate how much profit a landlord is likely to make. A lender’s interest cover ratio is the ratio to which a property’s rental income must cover the landlord’s mortgage payments, tested at a representative interest rate (most banks currently use a higher rate to be safe). Lenders are required to test at 125% (meaning the projected rental income must be a quarter more than the mortgage payments), but many impose stricter rules.
Landlords with four or more properties are often described as ‘portfolio landlords’. This is an important distinction, as rules introduced by the Bank of England’s Prudential Regulation Authority in October 2017 made it harder for these investors to access additional finance. Previously, portfolio landlords could provide their overall profit/loss figures when applying to borrow more money or remortgage a home in their portfolio. This has now changed and instead, you’ll now need to show mortgage details, cash flow projections and business models for every property you own when applying for finance. If you have a heavily mortgaged portfolio, you will find that these regulations make it more difficult for you to obtain extra funds.
Portfolio landlords also face some other restrictions, which vary from lender-to-lender. For example, some lenders will set a maximum number of properties they allow you to have in your portfolio (up to 10 being the most common) and others use different interest cover ratios and representative interest rates depending on how many properties you have. Other rules imposed by individual lenders include limits on maximum loan-to-value ratios across a portfolio (for example, your overall portfolio must be at 65% loan-to-value or lower) or the stipulation that the interest cover ratio from every property in your portfolio must be above 100%.
With landlords struggling to get finance, some banks have begun to adopt a more holistic approach to lending by introducing a system known as ‘top-slicing’. Top-slicing takes into account a landlord’s personal income separate to their portfolio – such as a salary or pension income – and includes it in affordability assessments. This means that if you have significant earnings in addition to your property rent, you could theoretically use your personal income to bridge any shortfall when you are assessed by lenders. Only a handful of lenders currently adopt this approach, so if you think top slicing could benefit you, it is best to discuss this with your mortgage adviser.
A raft of taxation changes – including cuts to mortgage interest tax relief and the 3% stamp duty surcharge for property investors – has resulted in many landlords deciding to refinance their portfolios rather than adding to them. Indeed, data suggests that the number of landlords remortgaging has increased year-on-year. This means that while it might not be a great time to expand your portfolio, it could be a good time to find a good deal when remortgaging. The current trend in the remortgaging market is that lenders are cutting up-front fees on their products as they look to entice these landlords.
Accidental landlords: switching to a buy-to-let mortgage Not everyone who becomes a landlord necessarily set out to do so – for example, you might have inherited a property, or a change in your circumstances may have resulted in you moving back to the rented sector and choosing to let out your home due to the cost of Stamp Duty. Regardless of how you’ve become a landlord, it’s vital that you tell your mortgage lender if you’re going to let out a home that has an outstanding owner-occupier mortgage. Buy-to-let properties carry greater risks for lenders, so if you don’t tell your bank you could theoretically be invalidating your mortgage. Some lenders will grant you a ‘consent to let’ on your current deal, while others may insist on you switching to a buy-to-let mortgage.
Buy-to-let tax implications
Stamp duty on buy to let properties
If you’re buying a buy to let property or a second home in the UK, you’ll need to pay 3% extra stamp duty. This means the stamp duty on a buy-to-let home costing £250,000 will soar from £2,500 to a massive £10,000.
Income tax relief
In the past, landlords have been able to off-set mortgage interest and buy-to-let mortgage arrangement fees against their income tax bills at their marginal rate (up to 45% for higher earners).
However, this tax relief is being phased in over three years from 2017 and will be capped at 20%. Wealthier, higher tax paying landlords will therefore be the most affected. Experts warn that landlords could be up to £2000 per year worse off, based on typical rents. Cash buyers and investors in 20% tax band would be the least affected.
Choosing the right buy-to-let property
The property adage, location, location, location, is doubly important with buy-to-let.
Most people travel to work and the best buy-to-let investments are generally those within a fifteen minute walk of a train or tube station.
Find a property to suit local demand. A funky flat above a brasserie might suit commuting professionals but not a young family. Resale property is generally bigger and cheaper to buy than new build.
Be wary of buying into a block of flats with many other buy to let investors. Too many flats to let at the same time, means rents could fall or worse still, you may not find a tenant. It can also make selling harder.
Being a landlord comes with a wide range of legal responsibilities which include:
Contract – You must provide your tenant with a contract, generally an AST (Assured Shorthold Tenancy). This gives tenants the legal right to live in the property for a fixed or rolling term.
Right To Rent – All landlords are now responsible for checking their tenants have the right to rent in the UK. Give every tenant a copy of the Government’s How to Rent booklet.
Tenancy Deposit Protection – Protect your tenant’s deposit in government backed schemes such as Deposit Protection Service or Tenancy Deposit Scheme. Give your tenant details of where their deposit is protected.
Gas and Electrics – Check gas appliances annually using a gas safe registered tradesman and give tenants a copy of the safety certificate. Wiring and electrical appliances also need to be checked annually.
Energy Performance Certificate – Your property must have an up to date EPC before it can be marketed and you must give a copy to your tenant. An EPC is valid for ten years.
Fire – Furniture and soft furnishings must pass fire safety regulations. Check for fire retardant labels. Fire alarms have to be fitted. Fit a carbon monoxide alarm in any room with gas appliances.
Maintenance – as well as meeting legal requirements, you’ll want to maintain your property to a good standard for your tenants and in order to protect your investment. If you manage your own property it can be helpful to join a representative organisation such as The National Landlord’s Association or The Residential Landlord’s Association. Maintain a list of good plumbers and builders to help you manage your property smoothly.
How to make money from buy to let
The rent you charge should at least pay your mortgage and other fixed costs, but you can make a profit too:
- The rent you charge should be more than the cost of the monthly mortgage repayments. Although there can be other costs like insurance, repairs or letting agent fees, if you can charge more than these then the difference is your income or profit.
- You can make money if you can sell your property for more than you paid for it. The property’s price would have to increase more than the rate of inflation for this to be a real profit.
How much does buy to let cost?
Costs of buying the property
You will have to pay all of the same costs of buying a property for yourself like mortgage and solicitor’s fees.
Some fees are likely to be higher than on a normal mortgage:
- The deposit: Many lenders require a deposit of at least 25%, and some need even more, compared with as little as 5% for some owner-occupier mortgages.
- Mortgage fees: Several charges that come with the mortgage, like the arrangement fee, may be higher than for owner-occupier mortgages.
- Stamp duty: You have to pay stamp duty on any property worth more than £40,000 if it is not your main home. The amount is 3% higher for buy to let than residential properties.
Costs of owning the property
Once you have bought the property, you may have to pay for the following in addition to paying your mortgage every month:
- Renovating and improving it to make it legally safe to live in and attractive enough for someone to rent it.
- Paying letting agents for advertising the property and managing your tenants, which is usually charged as a percentage of the rental income.
- Maintaining the property and making any repairs needed.
Tax on your buy to let investment
You will pay tax on the profit you make from your buy to let investment, including:
- Income tax on profits you make from rental income
- Capital gains tax on profits you make from selling the property
The amount you are taxed on is the profit you have made minus allowable expenses like:
- Interest on your mortgage
- Maintenance and repairs
- Letting agent fees
- Utility bills
What are the risks of buy to let?
You should avoid investing in property if you cannot afford to risk losing money. You could make a loss in the short term or overall if:
- Your property is empty: If you cannot find tenants, you will make no rental income, meaning you will need to pay the mortgage yourself.
- You need to repair the property: You may need to spend money on fixing the property if it is damaged by tenants or by issues like subsidence or extreme weather.
- You have problem tenants: If they refuse to pay rent, damage your property or steal your belongings, you will be out of pocket.
- Interest rates rise: Your costs could increase if mortgage interest rates rise because this will push up the amount you need to repay each month.
- House prices fall: If you took out a buy to let mortgage and eventually sell the house for less than the mortgage amount you took out, you could make a loss. You will need to pay off the rest of its balance yourself.
You can protect yourself against the risks of being a landlord with insurance policies to cover your buildings, contents, legal liabilities and rental payments.
Buy to let FAQs
Q Can my first mortgage be buy to let?
A Yes, you might be able to get a buy to let mortgage, but most lenders will only accept you if you already own your own home.
Q Can I use “Help to Buy” for a buy to let property?
A No, you can only use this scheme for buying your own home.
Q Can I get a buy to let mortgage on my own home?
A No, this will count as mortgage fraud and could lead to your lender cancelling your mortgage and demanding payment for the entire balance in full.
Q Does it count as buy to let if I will be living in the property?
A If you will be cohabiting with someone else who pays you rent, you can get a normal mortgage, which is usually cheaper than buy to let.
Q Can you switch to buy to let?
A Yes, if you decide to rent out where you currently live, you will need to switch to a buy to let mortgage; here is how.
Q Are buy to let mortgages regulated?
A No, the Financial Conduct Authority does not regulate them unless you let property out to family. However, you can usually still complain to the Ombudsman if anything goes wrong.