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What is buy to let?

If you’re thinking of buying to let, it’s important to understand how buy to let works and what options and challenges come with a buy to let mortgage.

What is buy to let?

For many, the idea of buying a property as an investment feels safer than investing in stocks or shares, and it also allows a level of involvement. You can be a hands-on landlord or let an agency take care of your tenants, but many feel more comfortable investing in property at a variety of pricing levels.

But from Stamp Duty to buy to let mortgages, there’s a lot to get your head around. Here’s everything you need to know about buy to let.

What is buy to let?

Buy to let is when a property is bought specifically for the purposes of renting it out.

How does buy to let work?

When you buy to let you purchase the property and then act as the landlord, letting it out and charging rental payments. In order to make a profit, these payments should be higher than the cost of maintenance, letting agent fees (if applicable) and the monthly mortgage repayments.

You’ll still need to pay the deposit, mortgage fees and Stamp Duty when you purchase a buy to let property. If you already own a property, you will pay a higher rate of Stamp Duty.

You may also need to pay for renovation and improvements before you rent the property out for the first time.
You’ll need to pay income tax on your rental income. Like any self-employment, allowable expenses are deducted from your taxable allowance. Expenses include maintenance, insurance, letting agent fees and any utility bills you pay for the property.

Read more about income tax when you let property.

Buy to let mortgages explained

What is a buy to let mortgage?

A buy to let mortgage is simply a mortgage especially for a buy to let property. If you plan on renting out your property you must have a buy to let mortgage. It’s similar to an ordinary mortgage in that you borrow a large sum of money for a set period of time, but, because you won’t be living in the property, there are some important differences.

How buy to let mortgages work

The first difference is that the vast majority of buy to let mortgages are interest only – so your monthly payments will only pay off the interest on the loan and you don’t pay off the full sum (the capital) right away. This means that the monthly payments will be less, but you must be prepared to either pay off the loan in full, sell the house or remortgage at the end of the mortgage term. This means that you can buy the house and make money on the rent for the payment term (for example, 25 years) and then pay off the mortgage by selling the house at the end.

Repayment mortgages (where the capital and the interest are paid back in monthly instalments) are uncommon for buy to let properties. You’d have to charge more rent to cover the increased monthly price. However that means that at the end of the mortgage term you could either carry on letting it out and keep all of the rent yourself, or sell the house and keep the money, instead of having to use it to pay off a mortgage.

Another key difference between a residential and buy to let mortgage is that the amount you can apply for depends on the rent you’re planning on charging – not your salary. So if the property is large or ideally located, you’ll be able to charge more rent and so can get a larger mortgage.

The third difference is the deposit. Buy to let mortgages are considered much riskier than residential ones so lenders will often require a larger deposit, often at least 25%. Just like ordinary mortgages, the bigger the deposit the better the deal you’ll be offered, so you should put down as big a deposit as you can.

Lending restrictions

The Bank of England has recently started to impose tougher lending restrictions with strict affordability tests. Part of this includes using Interest Cover Ratios (ICRs). An ICR is the ratio to which a property’s rental income must cover the mortgage payments made by the landlord. Lenders can use this ratio to work out how much money the landlord is likely to make.

Many lenders want the predicted rental income to be 125% of the landlord’s mortgage payments. So, for example, if the landlord will receive a rental income of £750 per month, an ideal mortgage repayment amount would be £600 per month.

However, some lenders may want a higher ICR – sometimes as high as 145%.

Before any agreement is signed the lender will need to be confident that you’ll actually be able to get the rental income you’ve predicted. They often do this by looking at the price of similar properties in the area.

Mortgages for portfolio landlords

Portfolio landlords are landlords with four or more properties.

If you’re a portfolio landlord it’s a little more difficult for you to access additional finance. While you used to just be required to provide overall profit and loss figures when applying for a mortgage or remortgage, now you must show mortgage details, cash flow projections and business models for every property you own. If you have lots of mortgages in this portfolio, it will be harder to get another one.

There are a number of conditions that your lender might ask for:
  • There may be a maximum number of properties you’re allowed in your portfolio.
  • They may ask for a maximum Loan-To-Value ratio. The Loan-To-Value (LTV) ratio is the ratio of the loan to the value of the asset (the property in this case). So lenders may ask for an LTV of 65% or lower across your portfolio.
  • They might insist on every property in your portfolio having an ICR of at least 100%.
Some banks and lenders have adopted a system known as ‘top slicing’. This is when the landlord’s personal income (such as a pension or salary) is taken away from their portfolio and is included in affordability assessments. This means that if your personal income is significant you could use it to bridge any shortfalls.

Remortgaging

Sometimes refinancing can be a better option than buying more property, especially given the  Stamp Duty surcharge for property investors and cuts to mortgage interest tax relief.

There’s an increase in the number of lenders cutting up-front fees – according to Which? one in five remortgaging products are being offered on a no-fee basis. Cashback incentives are also on the rise.

Buy to let mortgages for first time buyers

Buying a property to let is a great option for first time buyers who live somewhere with high house prices, such as London. Buying a property to let out in a cheaper area can be a great additional income to go towards saving for a deposit.

However you will inevitably face some challenges. There will likely be fewer options available to you so you’ll need a bigger deposit and you won’t qualify for the Stamp Duty relief that most first-time buyers would. You will avoid the 3% surcharge that usually applies to buy to let buyers, but you’ll have to pay it if you buy a property for yourself or a second buy to let property without selling the first one beforehand. Also, remember that you can’t use Help To Buy for buy to let properties.

However it is possible for first time buyers to buy to let. In July 2019 online mortgage broker Habito announced it was launching a mortgage range for buy to let landlords, aimed specifically at first time buyers as well as self-employed, retired or older landlords. With a choice of fixed rate timeframes and no minimum income required, mortgages like these could be ideal for a first time buyer looking to buy to let.

Don’t worry though – if buying to let isn’t for you, there are other ways to save for a deposit.

Switching to a BTL mortgage

Some people find themselves becoming ‘accidental landlords’ – they own a house that was never intended to be rented out and so has an owner-occupier mortgage, but then they need to switch. This can happen for a number of reasons – for example you might move home but not want to sell you old property straight away, or you might inherit a property.

You must tell your mortgage lender if you plan on letting out a home that currently has an owner-occupier mortgage – to not do so might invalidate your mortgage.

What happens next depends on your lender. You might need to remortgage in which case you might need to change lenders, or you may be able to obtain ‘consent to let’ from your current lender.

Remember:

  • Some buy to let mortgages have very good rates but very high upfront costs. Make sure you know the details of the whole deal you’re getting.
  • Your rental income must be enough to cover your mortgage repayments and other buy to let expenses such as landlord’s insurance and management fees. Make sure you budget well before you buy, remembering that there will likely be periods where the property is empty between tenancies and there may be unexpected expenses like repairs (if they’re not covered by landlord’s insurance).
If you’re wanting to make a medium to long-term investment, buy to let could be for you. You just need to make sure you understand the details like buy to let mortgages, and the potential risks like a fluctuating housing market, to help you get the most from your investment.
Some other things to consider when thinking about buy to let:
  • Do you want to be a ‘hands on’ landlord, or would you rather hire an estate agency to deal with looking after the property, sourcing tenants and collecting rent?
  • Pick a property that will be a great choice for renters – remember you’re not picking a property for you. Find out more information about choosing a buy to let property. (LINK)
  • Are you willing to keep up to date with the changes to tenancy law? Some changes can have a big impact on the profit you make on the property, or even how to deal with evictions.
 

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