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All you need to know about buy-to-let mortgages

If you have a second property that you rent out, or you are buying a property for the purpose of renting it out rather than living it yourself and need finance to facilitate your purchase, you will need to get a buy-to-let mortgage.

This is a different type of mortgage product to the standard residential mortgage that you would apply for if you would be living in the property yourself.

A buy-to-let mortgage, also sometimes referred to as a ‘landlord mortgage’, is a loan designed specifically for properties bought with the sole intention of being rented out in order to generate an income for the owner.

It could be a residential rental property, student accommodation, a holiday rental or any other type of rental. Bear in mind, though, that some lenders do not accept applications for ‘house of multiple occupancy’ (HMO) so you may need a more specialist lender if HMO is your plan.

In this article, our expert team at PIL Southampton delves into the world of buy-to-let mortgages, explaining your options and what you will need to consider.


What is the difference between a residential mortgage and a buy-to-let mortgage?

Whereas a residential mortgage holder is likely to live at that property permanently, with a buy-to-let mortgage the owner is usually not allowed to live at the property; they specifically own the property in order to rent it to a third party to live there.

Another key difference between these two types of mortgages is that most buy-to-let mortgages are interest-only, whereas the majority of residential mortgages are repayment mortgages with the borrower paying off the loan during the course of the mortgage term as well as the interest on that loan.

Although eligibility requirements are fairly similar when you are applying for both types of mortgages, affordability is calculated differently.

Unlike with residential mortgages, where affordability is based on your personal income and expenditure, with buy-to-let mortgages the lender focuses on your projected rental income and the strength of the investment.

For this reason, most buy-to-let mortgages are not regulated by the Financial Conduct Authority.


How do buy-to-let mortgages work? 

A 25% deposit is usually the minimum. We talk more about deposits later in this article.

As we have mentioned, it is the norm for a buy-to-let mortgage to be interest only rather than a repayment mortgage, to minimise monthly payments.

The borrower will have a funding plan in place to repay the full capital sum at the end of the mortgage term, or they may choose to sell the property at that time in order to be able to repay the mortgage debt.

There is a range of buy-to-let mortgages available, to suit various needs:

Standard buy-to-let: usually used to let out an individual home on a secure tenancy basis.

Consumer buy-to-let: geared towards people who have become ‘accidental landlords’ through circumstance rather than choice. As becoming a landlord this way isn’t a predominantly financial decision, these mortgages are regulated by the Financial Conduct Authority.

Family or regulated buy-to-let: this is similar to the consumer buy-to-let, used specifically to let property to close family members and is not profit driven.

HMO mortgage: a standard buy-to-let mortgage product given a separate definition as not all lenders offer mortgages for ‘house of multiple occupancy’ (HMO) properties and an HMO mortgage tends to have more regulations than a standard buy-to-let mortgage.


How much does a buy-to-let mortgage cost?

The cost of your buy-to-let mortgage will depend on the size of the deposit you can come up with as the less you need to borrow the lower your monthly interest payments will be.

You will also need to consider the arrangement fee you will be charged to set up your buy-to-let mortgage, and any survey costs.

The interest rates you will be offered will be determined by various factors including your credit history – as a rule of thumb, the poorer your credit history, the higher the interest rate you will be offered as the lender will deem you to be a higher risk.

Other factors your lender will take into account include your loan-to-value (LTV) ratio, the Bank of England’s base rate and whether your mortgage is on a fixed or variable rate. Fixed rate mortgage interest rates are generally higher, as you are paying for the privilege of guaranteed, unchanging monthly payments.

However, although it means that your monthly payment may fluctuate, a tracker or variable-rate mortgage product could work out cheaper in the long term.

It is always worth shopping around and comparing the different deals available from various lenders, a mortgage adviser can help you with this as they are working with these products every day.


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

Whereas the borrowing for a residential mortgage is generally calculated by multiplying the applicant’s income, with a buy-to-let mortgage application the lender will concentrate on the level of anticipated rental income.

Generally, the lender will require your forecast rental income to be at least 25-30% higher than your mortgage payment.

Some lenders do offer buy-to-let mortgages with no upper borrowing limit, but eligibility assessments are still strict. It can be helpful for applicants to get a rental income forecast from an ARLA-regulated letting agent to back up their application. 


What are the rental returns and yield requirements for a buy-to-let property?

The majority of buy-to-let mortgage lenders have minimum projected rental return (‘rental ROI’) requirements. 

You calculate your rental return by subtracting your mortgage and running costs from your predicted rental income, which is then divided by the amount of money you invested when you purchased the property. 

Most lenders will need to see a rental return of at least 125%, which they will stress test by using your predicted rental income and your qualifying mortgage rate.

The ‘rental yield’ is the term used to describe your income on your buy-to-let property, and this amount is calculated by measuring the difference between your total costs and the income you receive from letting out the property.

The calculation divides the purchase price by the annual rent generated. A rental yield of at least 8% is usually considered to be a decent investment.

To give an example, if your property cost you £250,000 to buy, and your tenants are paying you £1,500 per calendar month in rent, your annual income is £18,000 and your rental yield is just under 14%.


Who is eligible for a buy-to-let mortgage? 

Most lenders will generally only lend to borrowers aged at least 21, who have a good credit score. Their decision will be influenced by your borrowing history so it is wise to make sure that your credit score is as high as you can get it before you apply for a buy-to-let mortgage.

It is not impossible to get a buy-to-let mortgage with a poor credit score, but your options are likely to be more limited and your interest rate higher.

You may also be more limited in your choice of lender if you are over 75, as some lenders have age caps for when you take a mortgage out and when the term finishes.

Although most buy-to-let mortgage providers base affordability on projected rental income, some lenders may also factor in other income, even if you plan for your buy-to-let mortgage to be self-funding.

£25,000 is usually the minimum annual income that lenders will want you to prove that you are generating from other sources, especially if you are a first-time landlord.

Mortgage lenders will usually not consider a first-time buyer for a buy-to-let mortgage, and they may also want you to have owned your own home for a certain period of time.

In most cases, mortgage lenders find applicants who have landlord experience a more attractive proposition, as they will be reassured to see evidence of a strong track record in managing rental properties.

If you fall into the category of being a first-time buyer or a first-time landlord, there may still be options available and we can help to find these for you.


Can you take out more than one buy-to-let mortgage?

Yes, there is technically no limit to how many buy-to-let mortgages you can take out, as long as you can prove affordability. 

However, the more buy-to-let mortgages you have, the more difficult you are likely to find it to get accepted for another one. Some lenders are reluctant to lend to ‘portfolio landlords’ which is the term for those with more than four active buy-to-let mortgages.

There are specialist lenders who will be able to help this category of borrower and your mortgage adviser will be able to help you with this.


How big a deposit do you need for a buy-to-let mortgage? 

Deposit levels are higher than is required for a standard residential mortgage, due to the lender viewing them as a riskier investment.

The minimum deposit required for a buy-to-let mortgage is generally 25%, although some lenders will ask for up to 40%. The percentage could be determined by your income, your credit history, and the lender’s criteria.

If it is difficult for you to come up with a suitable deposit for your buy-to-let mortgage and it is a second property, you could consider using some of the equity in your first property to put towards your buy-to-let investment, although we would always recommend that you take advice from a qualified financial adviser before making any key financial decisions.

As with any mortgage product, it is generally the case that the bigger deposit you can put down the lower the interest rate will be, and the more favourable terms you will get.


What should you consider before choosing a buy-to-let mortgage? 

There are several factors specific to a buy-to-let mortgage that don’t apply to a standard residential mortgage that you should take into account before you commit.

Tax implications are a key consideration, both on your rental income and when you come to sell the property. The income tax rate you pay will be impacted by the amount of rental you are earning.

When you sell a buy-to-let property, you will be liable to pay Capital Gains Tax (CGT) on a proportion of your profit.

Before you commit to a buy-to-let property, you need to make sure that you have sufficient reserves in place to cover those periods when your property is unoccupied and you don’t have tenants paying you rent to cover your mortgage repayments.

Also, think about how long you will need the initial mortgage period to last and whether your financial circumstances may be different when it is time to remortgage. 


What are the benefits of buy-to-let? 

Buy-to-let is a popular option for many investors. 

Your investment should generate a regular, passive income, as well as being a potentially lucrative long-term investment if house prices continue to rise.

Although past performance is no guarantee of future results, UK property values have generally increased over time, which can make this a good opportunity for a significantly higher return on your investment than other methods of growing your wealth. 

A buy-to-let property adds diversity to your investment portfolio and spreads your risk.

It is also worth noting that, if property values and rental income keep up with inflation, your purchasing power will be maintained.

There are tax benefits, as well. At the time of writing, landlords receive a 20% tax credit on their interest payments, meaning that they can reclaim some of their buy-to-let property running costs when they are submitting their annual tax return.


What are the drawbacks of buy-to-let?

There is no guarantee that you will always be able to rent out your property and that your tenants will be reliable tenants who pay their rent consistently and on time.

This could leave you in a ‘payment void’ situation where you still have to make your mortgage payments even when you have no rental income coming in.

You will also be responsible for managing and maintaining the property, or you could choose to reduce your net income by paying an agent to manage the property on your behalf.

Other additional costs include landlord responsibilities like gas safety certification and buildings insurance.

If you are unlucky, you could get a tenant who causes damage that proves very costly for you. 

It could be worth considering taking out landlords’ insurance to protect you from tenants’ damage, or from times when your property is vacant and when you are not receiving rental income.

Tax-wise, at the time of writing, in England and Northern Ireland you pay 3% more on each rate band of stamp duty for a buy-to-let property than you do on a residential property. In Scotland it’s 6% above the standard rates and in Wales it’s 4% above standard rates.

Stamp duty applies to any property above £40,000 and these extra percentage points could run into thousands of pounds which you need to budget for in your upfront costs.

Note: First-time buyer stamp duty relief doesn’t apply to first-time buyers who are buying a buy-to-let property.

Now that buy-to-let tax relief has been replaced by the 20% tax credit, higher or additional-rate taxpayers cannot now claim the tax back on their mortgage repayments. 

When you come to sell your buy-to-let property, any profit over £12,571, at the time of writing, will be liable to Capital Gains Tax (CGT). Currently, the rate of CGT is 18% for basic rate taxpayers and 28% for higher or additional rate taxpayers.


What if you already have a standard residential mortgage on a property that you later choose to rent out?

In this instance, you must inform your lender of your intentions before you rent out your property as it is likely to be against the terms of your loan and would amount to mortgage fraud.

Some residential mortgages will not allow you to let your property, in which case you will have to remortgage and take up a buy-to-let mortgage.

Other lenders may let you continue with your residential mortgage, by asking you to apply for ‘Consent to Let’, also referred to as ‘Consent to Lease’.

They are likely to ask you to confirm that you didn’t originally purchase your property as an investment because, if that had been your intention at the time, you should have chosen a buy-to-let mortgage at that point.

If you are thinking about an Airbnb scenario, renting out one or two rooms, or your whole property, it’s still important to talk to your lender first, to make sure you are not breaching the terms and conditions of your mortgage. There may be a maximum number of days per year that you could rent your property out, for example.


How PIL Southampton can help you 

People looking for a buy-to-let mortgage are usually doing so for investment purposes so it is crucial that you get the best deal available to maximise your potential profits.

Our personable team of experienced mortgage advisers appreciates that every individual has different circumstances.

We will take the time to get to know you, then combine that data and information with our up-to-the-minute knowledge of the mortgage marketplace to find and advise you on the most appropriate mortgage product to suit your needs.

How you can contact PIL Southampton

Our expert mortgage advisers are here to guide you through the mortgage process, every step of the way. You can email us, fill out the contact form on our website or call us on 02380 668407. We look forward to hearing from you.