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The moneyfacts.co.uk guide to buy-to-let mortgages

The moneyfacts.co.uk guide to buy-to-let mortgages

Category: Buy To Let

Whether you're a newbie to buy-to-let, or a seasoned investor, one of the most important things when it comes to managing your property or portfolio of properties, is to understand how buy-to-let mortgages work.

So read on for the moneyfacts.co.uk guide to buy-to-let properties and buy-to-let mortgages

It's all about income

Buy-to-let properties can make you money in two ways:

  • Capital growth (the value of your property going up)

and

  • Rental income

However, as much as you can make money, you can also lose it if:

  • Property prices go down – you lose money on the value of the flat or house

or

  • You have trouble finding tenants to fill the property, or getting the level of rent you need to break even

At present, with the property market improving and house prices rising, it may be the time to think about becoming a buy-to-let investor.

However, make sure you understand the investment risks associated with a buy-to-let property. If unsure, seek the advice of an independent financial adviser.

Renting out your home

Some people fall into becoming landlords. You meet a new partner and move into their property, keeping your own to rent. You might move abroad to work, but want to keep your home in the UK. You might even have had trouble selling your property…

Whatever the reason, it's important you make the transition from the property being your home to an investment properly. This includes:

  • Telling your mortgage lender. You'd be surprised how many people don't do this! The mortgage lender needs to give you formal "consent to let". It may, but not always, mean that you are put onto a higher buy-to-let rate of interest. If your payments go up, it may be worth shopping around for a new buy-to-let mortgage. And remember failure to notify your mortgage lender that you are letting out your property will put you in breach of your mortgage agreement.
  • Tell your insurer. Standard Buildings and Contents insurance will not cover you if the property is let. So you will probably need to arrange landlords insurance instead.
  • Speak to a professional letting agent (preferably one that's a member of the Association of Residential Letting Agents). If you aren't in a position to be too hands on (or just don't want to be!), a letting agent can help with the work of managing your property. They can also help with the process of setting yourself up as a landlord (such as helping you sort out an Energy Performance Certificate for instance).

A letting agent should use an approved Tenancy Deposit Protection scheme, and carry out comprehensive checks on prospective tenants for you.

  • Speak to an accountant or tax adviser as there are tax implications for buy-to-let properties which you may not be aware of.

Taxation of buy-to-let

A buy-to-let investment attracts several different taxes. Setting aside Stamp Duty – which you have to pay when you purchase any property worth more than £125,000 – you may also have to pay Income Tax on the rent you receive and Capital Gains Tax when you sell the property.

Rental income must be declared on a Self Assessment tax return (the amount you pay will be subject to your tax banding). However, you can deduct costs such as mortgage interest and letting agency fees from the rent you receive first.

And like anything else you own, a buy-to-let property will form part of your estate for Inheritance Tax purposes.

If you are unsure, seek the services of a good accountant (your letting agent may be able to recommend one used to dealing with buy-to-let).

Buy-to-let mortgages

For all intents and purposes, a buy-to-let mortgage operates in a very similar way as a mortgage on your home (which is sometimes also called a residential mortgage), with the same types of rates and the same kinds of fees and charges. But if you're new to all this, a buy-to-let mortgage does have a few key differences which are worth being aware of:

  • Mortgage interest rates

Rates for buy-to-let mortgages tend to be higher than those for a mortgage on your home.

  • Deposit/Equity

The amount you can borrow in relation to the value of the property (loan-to value, or LTV) is generally lower for buy-to-let mortgages. The maximum you could hope to borrow is currently 80% of the property's value, compared to a residential mortgage where you could borrow 95%.

  • Fees are generally higher

Arrangement fees on buy-to-let mortgages can be a lot higher than on a residential mortgage, with percentage-based fees of up to 3.5% of the mortgage amount charged to secure the cheapest fixed or tracker rates.

  • Income Assessment

One of the key areas of difference between a buy-to-let mortgage and a mortgage on your home is how affordability is assessed. For a residential mortgage, income from employment, pension, benefits and a myriad of other sources is used to determine whether you can afford the mortgage repayment.

But for a buy-to-let mortgage income is usually assessed as a percentage of the mortgage payment, typically at least 125%. So, if your mortgage payment is £600 per month, you need to be getting rent of at least £750. Crucially, the "rental value" of your property needs to be verified by the surveyor who conducts the mortgage valuation.

If you opt for one of the lower fixed or tracker rate buy-to-let mortgages, you may find that the lender calculates whether you can afford the payment not on the amount you initially pay, but on the rate you would revert to at the end of the initial period (in some instances they may even use a higher "managed rate" to ensure you can afford the mortgage).

For example, if you're on a fixed rate of 4.00% for two years, reverting to a variable rate of 6.00%, the lender might conduct their affordability check based on a percentage (again, in all likelihood, at least 125%) of what your payment would be at 6%.

Sometimes a lender will allow your personal income to be assessed either using a multiple of what you earn (or receive) or by assessing your finances more holistically in what is known as your "ability to pay". A mortgage that is assessed in this way could be the route to go if you want to have your buy-to-let mortgage on full repayment (as the payment on this is more expensive than the usual method of interest only).

Finally, a lender may specify that you need a minimum income level to give them some comfort that you have other resources to fall on, should you have trouble with under-occupancy or rental arrears.

Things to watch out for...

Affordability - your mortgage lender may only assess whether you can afford the monthly mortgage payment, but we all know that the day-to-day costs of letting a property don't end there. There's also:

  • Letting agent fees (if you use one). Using a letting agent can really take the burden off you, particularly if you're a first time landlord.
  • Maintenance costs
  • Annual safety checks
  • Landlords insurance (to protect the building and any contents)
  • Rent insurance (which protects you during periods of un-occupancy or arrears
  • You might even be paying into an investment, such as an ISA, Stocks and Shares ISA or Pension, with the hope of repaying your buy-to-let mortgage and owning the property outright at the end of the term

These costs may not be taken into account by the mortgage lender, so make sure that you can afford it all before you proceed.

Fussy lending conditions

Whereas a mortgage on your home will only be on one property; a buy-to-let mortgage can be on several properties. So it's worth checking the following before proceeding with your buy-to-let mortgage application:

  1. Minimum valuation - Some lenders will only lend on properties valued above a certain level. Whilst this is usually a nominal amount of £40,000 to £50,000 (we're sure you'd agree that there aren't many properties around at those prices!), some stipulate minimum valuations at the far more plausible level of £100,000 plus.
  2. Property Type - If the property you own is of unusual construction (some forms of concrete ex-local authority houses for example) you may already be well versed in which lenders will be happy to lend. Something that has emerged more recently though is the difficulty of landlords with new build flats to secure buy-to-let mortgages, as the perception is that these are over-valued
  3. Portfolio - Some lenders will restrict the number of properties you can have on one buy-to-let mortgage and/or the maximum amount that they will lend. This may not mean that you can put in multiple applications with the same lender either as you may only be able to have a certain number of properties mortgaged with the same lender, or even the same parent group.
  4. Age - Your age can play a part in whether you can have a particular buy-to-let mortgage, or how long the term can be over. Although not all do this, many lenders will limit the mortgage term to when you reach the age of anywhere between 70 and 90. So be aware of this if you're intending for a buy-to-let property to augment your income in retirement.

Use a BTL mortgage broker

If you thought getting a mortgage on your home was tough, the buy-to-let market can be an absolute nightmare in comparison! So using the services of an experienced buy-to-let mortgage broker can be invaluable in helping you to navigate through the nuances of different lenders'conditions.

Couple this with the fact that a broker can have access to mortgages you wouldn't be able to get (although conversely, a broker will not have access to some mortgages that are only available if you apply to a lender directly) and the argument for using a mortgage broker becomes even more compelling!

Guide Updated: 03/03/14

What Next?

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More guide to buy to let

Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.

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