What is a buy-to-let mortgage?

What is a buy-to-let mortgage? And how do you get one?

With a growing generation of first-time buyers choosing to rent rather than own a home, purchasing a property to let it out is a popular option for investors. Large deposits and high prices, fuelled by low supply levels, have contributed to the general shift towards renting, with homeownership declining for both lifestyle and financial reasons.

Buy-to-let investments can therefore be a lucractive opportunity, with high demand for accommodation promising reliable returns on a property purchase. Financing, though, is often necessity for would-be landlords. Fortunately, buy-to-let mortgages are a widely available product, with major lenders offering mortgages designed specifically for those planning to rent their property out.
How exactly does it work? And how do you get one?

Buy-to-let mortgages: The basics

Put simply, a buy-to-let mortgage loans you the money you need to buy a home to rent it out.

Financing for a buy-to-let purchase differs from a traditional residential mortgage, with loans issued on an interest-only basis. That means you can minimise your debts, beause your repayments will pay off the interest rather than loan itself.

While a conventional mortgage would charge you repayments on both some of the loan and the interest every month, a buy-to-let mortgage means that you can keep the rental income yourself. When you sell the property, the actual mortgage amount is due to be repaid, as well as Capital Gains Tax on the property’s capital growth.

You can normally obtain a relatively high LTV mortgage from lenders, which means you can get started with your investment for a fairly low sum. In 2016, UK buy-to-let mortgage rates have also been low, as lenders compete to woo borrowers, which means that conditions remain favourable, despite the recent introduction of a stamp duty surcharge on any UK buy-to-let purchase.

Read more: Does the 2016 Stamp Duty surcharge apply to me?

How do I get a buy to let mortgage?

Buy-to-let mortgages come in all shapes and sizes, from fixed and variable to tracker products. Because you will be receiving money from your property, though, lenders will consider your rental income when deciding whether they will lend you a buy-to-let mortgage, as well as how much you can borrow. Your overall income will be considered too, as with a standard mortgage.

Because a buy-to-let investment is riskier than a traditional property purchase, you should be prepared to save up a higher deposit to secure your loan; after all, there is always the danger that you may be faced with a void period or troublesome tenant, which could potentially leave you unable to pay off your interest fees every month. In the UK, a deposit is typically in the region of 25 per cent.

Owning an existing home, or already having a mortgage on a home, will help your case when applying for a buy-to-let mortgage, as will a good credit rating and a sizeable salary. Some lenders may set a limit on your loan, based on your age, requiring the mortgage to end, for example, when you turn 90 or 70.

Read more: What is a good yield on buy-to-let property?

How much can I borrow for a buy-to-let mortgage?

The amount you can borrow depends largely on the rental income expected to be generated by your property – which means your choice of property and location will determine, to an extent, your buy-to-let mortgage.

Lenders will traditionally require your rental income to be around 125 per cent more than your mortgage payments. However, in the UK, the government and the Bank of England are both cracking down on the buy-to-let sector, which means that you may require a much higher rental income to secure the same loan: tougher restrictions during the approval process could see landlords required to receive 145 per cent of their mortgage payments from their rental income, or higher. Indeed, some lenders in 2016 have already begun to tighten their restrictions.

Stress tests will also be carried out to determine whether you could afford your mortgage payments in an unexpectedly higher interest rate environment of 5.5 per cent.

Mortgage interest is a crucial part of a buy-to-let investment in the UK, because from April 2017, a new tax change will be introduced, which will gradually remove landlords’ ability to offset mortgage interest payments against rental income before their tax bill is determined. You will effectively have to pay tax on turnover rather than profit, which will mean that many will have no choice but to raise rents.

Read more: What can you do to fight the Tenant Tax?

What are the typical rates?

Buy-to-let mortgage rates tend to be higher than those for a normal residential mortgage. Despite the government crackdown on buy-to-let mortgage approvals and tax changes, though, UK lenders have been increasingly competitive this year to offer attractive buy-to-let mortgage rates. Indeed, with the Bank of England slashing the base rate to a record low of 0.25 per cent in 2016, mortgage rates, in general, are more affordable than ever. A recent report from Moneyfacts found that the average two-year fixed-rate BTL mortgage has fallen from 3.59 per cent to 3.32 per cent, while five-year rates have fallen from 4.37 per cent to 4 per cent.

To find out the best rates available, there are a wide number of price comparison websites available. In the UK, Moneyfacts, Money Saving Expert, MoneySuperMarket and uSwitch are all worth consulting.

What do I do when I sell?

Buy-to-let property is not normally a short-term investment, but when you do sell the property, you will be expected to repay the mortgage amount. Your sales price will often be able to cover this, although property prices can vary, so this is never guaranteed.

If your house price has fallen over the years since your purchased it, you will require more money to pay off the difference on the mortgage. If your house price has risen, you will have to pay Capital Gains Tax, if the amount exceeds the CGT threshold.

Will my costs go up in the future?

The mortgage interest tax relief changes will be a major change to the UK’s buy-to-let market. The new rules will be phased in from April 2017 and become fully implemented in 2020. From then, you will not be able to deduct the cost of your mortgage interest from your rental income before calculating your tax, which will leave you paying tax on a non-existent income. When taking out a buy-to-let mortgage, therefore, pay particular attention to your mortgage interest and your expected rental income.

Under the current rules, a landlord with a £375,000 home generating an income of £350 a week with a 75 per cent LTV mortgage would have a turnover of £18,200 a year. Allowing for £5,000 expenses, and deducting the mortgage interest of £9,140, the profit would be £4,060, incurring a tax bill of £1,624 – and a final take-home sum of £2,436.

Under the new rules, the same landlord would not be able to deduct their mortgage interest, instead declaring £13,200 profit. Even taking into account the 20 per cent tax credit landlords would receive on their mortgage interest (£1,828), the final tax bill would be £3,582, taking the effective tax rate from 40 per cent to 80 per cent and cutting the take-home earnings from £2,436 down to £608.

How can I reduce my costs

Incorporation may be a route worth considering, as companies that invest in buy-to-let property will not be affected by the UK’s new tax laws.

Alternatively, other buy-to-let investments are available around the world, such as Enclave, a stylish and high-quality development in the affluent area of East Perth, Australia. The investment offers 70 per cent LTV buy-to-let mortgages for units that start at AUS$420,000 and generate a 4.75 per cent yield.

Buy-to-let investments can also be dealt with in cash. For example, New China Town, an off-plan development in the heart of Liverpool’s Chinatown, is available to buy-to-let investors from £126,000, with higher yields of 7 per cent.

Read more: Should I incorporate to avoid the new Tenant Tax?