Topics
Buy-to-Let Mortgages Explained
Thinking about diving into the exciting world of property investment in the UK? You’re not alone!
In spite of recent government initiatives that were expected to dampen buy-to-let activity in the UK, it’s still a worthy investment. The housing market is facing a shortage of affordable homes, and house prices are going up. This means more people are looking to rent, and there are plenty of buy-to-let mortgages available.
That said, navigating the world of buy-to-let mortgages can be confusing, especially for first-time investors.
What is a buy-to-let mortgage?
When people want to enter the real estate investment market, they take out a buy-to-let (BTL) mortgage. You step into the landlord’s shoes with the goal of renting the investment property out to tenants, rather than living in it yourself.
The idea is to make money by charging rent that covers more than your monthly mortgage repayments, ideally leaving you with some extra income. When you eventually decide to sell the property, you would also be aiming for a a good amount of capital gain or profit.
Since BTL mortgages are seen as a business deal and carry a bit more risk for the lender, you will often find that associated fees and interest rates are higher compared to other mortgages. You would also be required to put down a larger deposit.
How does a buy-to-let mortgage work?
Buy-to-let mortgages are somewhat similar to regular residential mortgages in some ways. Having a large deposit or equity can improve your chances of securing a good deal. You will make monthly mortgage repayments, with lenders expecting the rental income to cover these.
The major difference is that most BTL mortgages are “interest-only”. This means your monthly payments go towards the interest on your mortgage, not the loan (or principal) amount. When this interest-only term ends, your repayments will cover both the interest and principal amounts.
What types of buy-to-let mortgages are there?
Much like a regular residential mortgage, there are a few options for buy-to-let mortgages. The two main types you’ll find are:
- Interest-only: These are the most common. With these mortgages, your monthly payments cover just the interest on the loan. The actual loan amount will not decrease unless you decide to sell the property or repay the loan.
- Repayment: Unlike interest-only mortgages, a repayment BTL mortgage requires you to pay the entire loan by the end of the mortgage term. Once it’s paid off, you can either continue renting the property or sell it.
Investors often lean towards interest-only BTL mortgages because they come with lower monthly payments. This means landlords can boost their profits while keeping their ongoing expenses in check.
Who Can Get a Buy-To-Let Mortgage?
BTL mortgages are available for both new and existing investors. However, many lenders view buy-to-let mortgages as riskier, so they might have certain conditions you need to meet. These can vary from lender to lender, but they often include the following:
- Some lenders might require that you already own a property, whether it’s fully paid off or you have an outstanding mortgage on it. This is not always the case though.
- Evidence of income separate from the rental earnings, usually around £25,000 or more per year.
- A minimum deposit of 25%, as lenders often have a loan-to-value (LTV) ratio limit of at least 75%.
- Demonstrate a solid credit history and not be overextended with other debts.
- At least 21 years of age when applying and no older than usually 70 or 75.
- You should be in a comfortable enough financial position to take on the investment risk that comes with a buy-to-let property.
How Much Can You Borrow for a Buy-To-Let Mortgage?
The maximum amount you can borrow depends on the expected rental income from the buy-to-let property. The higher the expected rental income, the more you can borrow. As a general guideline, your rental income should be enough to cover between 125% and 145% of your mortgage interest.
Your deposit also plays a role. It affects the lender’s willingness to lend to you, which impacts the loan-to-value ratio. There are other factors – such as your credit history, income, and expenses – that lenders will also consider.
To gauge your potential rental income, it is a smart move to consult local letting agents. They can give you an idea of the rental rates for similar buy-to-let properties in the area.
The Pros and Cons of Buy-To-Let Mortgages
Deciding if a buy-to-let mortgage is right for you involves understanding the potential pros and cons of this investment.
Pros
- Long-term investment gains: A well-chosen buy-to-let property can be a source of both immediate rental income and long-term investment potential. Over time, the property value may rise, opening the door to future profits through a sale or remortgage.
- Strong rental market: There’s a sustained demand for quality rental properties, especially in specific UK regions. Many landlords with buy-to-let properties are benefitting from this demand.
- Tenant contributions: Your tenants essentially cover your buy-to-let mortgage, and if your rent exceeds your mortgage payments, you’ll have an additional income source.
- Tax benefits: Some of the expenses associated with buy-to-let properties can be reclaimed when you file your Self-Assessment Tax Return. This includes mortgage interest, letting agent fees, maintenance expenses, and council tax.
Cons
- Tenant-related risks: Dealing with tenants carries inherent risks, including the potential for rental gaps, arrears, or property damage. For this reason, many landlords opt for comprehensive landlord insurance.
- Market uncertainty: Property prices can fluctuate, and there is the potential to lose money if you sell at a lower price than what you initially paid.
- Repayment plans: If your buy-to-let mortgage is interest-only, you will need a plan to pay back the loan at the end of the term. If the property’s value drops, you might face a financial gap.
- Higher stamp duty: A buy-to-let property has a higher stamp duty, which is 3% more compared to residential purchases.
- Capital gains tax (CGT): If you make a profit when selling a buy-to-let property, you might need to pay CGT.
What to Consider Before Taking Out a Buy-To-Let Mortgage
Before you jump into a buy-to-let mortgage, there are a few considerations you should keep in mind:
1. Tax implications
Rental income and property sales can bring tax obligations. The amount you take from the rent will determine how much income tax you owe.
Plus, when you eventually sell a buy-to-let property, you might need to pay CGT on some of your profits.
2. Rental income
Your property will not always have tenants, which could result in a time when you are not receiving income from your property. It is essential to have a financial cushion for these ‘void periods’ to ensure you can continue making your mortgage payments.
3. Loan term
Decide how long you want your initial mortgage agreement to last and what steps you will take when it comes to an end. If your financial circumstances change, you might consider remortgaging or selling the property.
4. Additional expenses
Besides your regular mortgage payments, there are some other financial implications when managing a rental property, including:
- Landlord insurance
- Legal expenses
- Product fees
- Property inspection
- Stamp duty
- Agent fees
- Property maintenance
- Tenant safety
- Energy efficiency
FAQs
How much deposit is needed for a buy-to-let mortgage?
In most cases, you will need a minimum deposit of 25% of the property’s value to secure a buy-to-let mortgage. Some lenders may consider a 20% deposit, but a larger deposit can improve your chances of accessing better BTL mortgage rates.
How are buy-to-let mortgages different from residential mortgages?
With a regular residential mortgage, homeowners make monthly payments that cover both the loan amount and the interest. Buy-to-let mortgages are different and are mainly interest-only. With a BTL mortgage, landlords only pay the interest on the loan each month but will need to pay both the loan amount and interest when the interest-only term comes to an end.
How do I apply for a buy-to-let mortgage?
There are a few ways you can go about applying for a buy-to-let mortgage: you can visit a high street lender and tackle the application on your or or you can work with a mortgage broker.
The latter is always the best option as they know the ins and outs of mortgages. A broker will guide you through the entire application, from helping you gauge your projected rental income and checking your credit to finding the best mortgage lender and managing your application.
Sources:
https://www.trackcapital.co.uk/news-articles/explained-the-buy-to-let-mortgage/
https://www.moneyhelper.org.uk/en/homes/buying-a-home/buy-to-let-mortgages-explained