Buy to Let Mortgage

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Buy to Let Mortgage

Buy to Let Mortgage

Dion Stocks explains how Buy to Let mortgages work and what’s involved in taking out this kind of product. 

What is a Buy to Let mortgage? How does it differ from a regular mortgage?

A Buy to Let mortgage allows you to buy investment property. It differs from a residential mortgage because you are not allowed to live in that rental property, whereas a residential mortgage is for a property you will live in. 

A Buy to Let property is a vehicle to earn you an income. It’s an investment for the long term, whether for your retirement or to give you extra income to put children through school, for example, or to build up a portfolio. You may leave your day-to-day job one day and become a professional landlord, building up a company that allows you an income and more freedom.

What are the eligibility criteria for a Buy to Let mortgage?

As an applicant for a Buy to Let mortgage, you need to be over 18 or older, depending on the lender. Many things are lender dependent and criteria dependent. Typically, you also need to be a residential homeowner. 

They often ask that you have an income in the background of at least £20,000 per annum. Again, it’s lender specific. Some lenders just want to know that you have an income. 

To assess the affordability of the mortgage, lenders focus purely on the rent that’s coming in and whether that covers the mortgage. They need peace of mind that if there were any void periods you would be able to cover the mortgage payments.

What is rental coverage and how does it affect Buy to Let mortgage applications? 

This is about the interest coverage ratio, which gives the lender peace of mind that the Buy to Let mortgage is affordable. 

It’s based on a stress test of the rental income at a certain interest rate. Let’s say you were looking to get a mortgage for £150,000. That’s 75% of the overall purchase price, because your deposit on a Buy to Let mortgage is normally 25%. A few lenders will stretch to a 20% deposit, but let’s just go with the vast majority. 

With a mortgage at £150,000, lenders then apply a theoretical interest rate. It might be the interest rate attached to that mortgage product plus 2%, or an arbitrary interest rate of 5.5%, – whichever is the higher.

In this theoretical instance, a typical mortgage rate plus 2% comes out at 5.64%. So the lender multiplies the £150,000 by 5.64%, which gives a figure of £8,460 a year. That’s the rental income you would need to cover that 5.64% interest rate. 

Divided by twelve, that comes out at a monthly rental income of £705. They than add an amount on top of that – often a 30% buffer, to cover your other costs. So if your rental income is at this level, you should be fine. 

The size of that buffer is dictated by whether you’re a low rate taxpayer, high rate taxpayer, whether it’s for a House of Multiple Occupancy (HMO) or whether you’ve registered a limited company to buy the property.

If you were a lower rate taxpayer at 30%, the calculation would be £705 multiplied by 130%, giving a rental income of £916.50. That’s the maximum rental income that you would need to cover the mortgage, at a stress level that’s over and above the norm.

How much deposit is usually required for a Buy to Let mortgage?

The average across the industry is a 25% deposit, or 75% Loan to Value. A few lenders will stretch the borrowing to 80%, but they are very few and far between. 

Should I choose interest only or repayment on a Buy to Let mortgage?

This comes down to your personal circumstances and the overall business plan for you and your future portfolio. 

With a five year fixed rate at 3.99% on interest only, the monthly repayments are £374. It’s quite low. In the scenario with the interest cover ratio, we had an assumed rental income of £916. 

So if you had £1000 income from that property, you’ve got more than £600 left after the mortgage payments. That doesn’t take into account any other costs like management fees, insurance, et cetera. But it’s quite a healthy profit. 

On a capital repayment mortgage on the same five year fixed at 3.99%, the monthly payment is £831. That’s because your repayments are eating away at that £150,000 owed.

But the amount of money you have after the mortgage payment is a heck of a lot less than on interest only. 

With a £831 mortgage payment and an assumed rental income of £1000, you’ve got a lot less to play with. From that you’ve got management costs, insurance, etc. As a landlord, you’re working hard for this, so you deserve a little bit of income but there’s a lot less in the pot there. 

So speak to an accountant and get a full understanding of your finances, to see which is the better option for you. On paper, interest only would be the obvious choice. 

All these mortgages come with the ability to make overpayments of up to 10% of the balance per annum. I advise my clients to try and build up some funds, either to purchase another property, or start paying down some of the mortgage balance.

With interest only, over a term of 15 years, you will still owe £150,000 at the end of that term. It doesn’t change unless you pay down the balance. If you were to chip away at that, over time you will have more equity in the property and retain more of the rental income because less interest will be due on the capital balance as it reduces. 

Are there any specific fees associated with a Buy to Let mortgage that borrowers should be aware of?

Generally they’re the same as with a residential mortgage. You have a product fee or arrangement fee, legal fees and valuation fees. 

Depending on the product and lenders’ promotions, you may have no legal costs or free valuations. Most lenders in the market do attach a product fee to their mortgages, which can vary from the standard £999 up to an eye watering 7% or 10% of the mortgage amount. That’s quite an extreme amount of money. 

You can add product fees to the mortgage, but it will be accruing interest. I say to clients who add the product fee to the mortgage, that if they have the money in five months’ time or a year’s time, pay it off straight away. Otherwise it’s attracting 5% interest on top of your mortgage [podcast recorded in February 2024].

What factors do lenders typically consider when assessing a Buy to Let mortgage application? 

Lenders like you to have a residential mortgage in the background. It gives them peace of mind that you are able to manage your money and pay the mortgage every month of the year. 

If you have multiple properties, some lenders will cap your portfolio at four properties. Others cap the total number of properties in the portfolio at ten – if you have any more than that, they can’t lend. 

More lenders will now limit all the lending on the portfolio to £3 million or £5 million. Again, there are certain lenders outside of that who don’t set limits. 

It also depends whether you are buying as an individual or in a limited company. You need a specific type of limited company called a Special Purpose Vehicle. The vast majority of lenders now require that – it’s a company dedicated to buying property with the intention of letting it out. 

When you register the limited company at Companies House, there are four specific ‘SIC’ codes that lenders look for. Having the right codes means the business has been set up correctly as a Special Purpose Vehicle for Buy to Let.

A few lenders, again, are happy for you to buy a property within an operating company. They want to know that the SIC code is attached to your business. So if you’re a builder and want to buy a property through the operating company, you can, but only specific lenders will look at that. 

One last thing is the number of applicants – and you can have up to four applicants on the mortgage.

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How do I find the right Buy to Let mortgage deal?

Speak to a broker. As this podcast is showing, it’s a bit of a minefield. You could think you’re going down a route that’s okay, then all of a sudden you find out it’s not going to happen with that lender and you’re back to square one. 

A broker that understands the Buy to Let market inside out will very quickly navigate you through to the lender that is going to be right for your criteria.

What are the implications of recent tax changes on Buy to Let mortgages?

It’s not so recent. The tax changes that impacted the Buy to Let market significantly were introduced back in 2016 and phased in over a four year period. We’re now four years on from that, so they should be well embedded and landlords are now fully aware of them. 

However, some landlords have been locked into really good deals, and those tax changes haven’t impacted them until now as they come out of their fixed rate products.  I would always advise you to speak to an accountant that understands property and the tax regimes at this moment in time to get a full understanding of what the implications are for yourself.

How does remortgaging a Buy to Let property work? When it may be advantageous?

It’s exactly the same as with residential property. When you are coming to the end of your fixed deal, whether it’s a two, three or five year period, you then switch to the standard variable rate, which is always going to be higher. 

With base rates as we speak in February 2024 currently at 5.25%, the standard variable rate will be a few percent above that. The norm is 7% or 8%. So you will be paying some heavy fees on a monthly basis. 

So start looking six months before that deal comes up. You can lock in a new deal for up to six months before the current one expires. 

This is all specific to the time when you do it and what’s happening in the market. It may be advantageous to switch rates if a new, superb rate comes out. Clients often come to me asking if they should switch to a new rate. 

But what you have to remember is all the costs, like the product fee and the valuation and legal fees to take into consideration. Plus, you’ve got early repayment charges if you end your product. If all of those add up and you’re still going to be saving money, then it might be worth it. But it needs to be a significant saving to even entertain the idea.

Are there any restrictions on using a Buy to Let mortgage for properties in certain areas or for specific tenant types?

A key restriction is that you cannot live in a Buy to Let property yourself. That would be described as a backdoor residential, because most people take a Buy to Let mortgage on an interest only basis. We’ve already shown that your monthly payments are a lot less on that basis. 

In terms of affordability, nine times out of ten it’s based on the rental income. So you could potentially get a mortgage at a much cheaper rate. But a Buy to Let mortgage contract is not set up like a residential contract. 

Also, in terms of specific tenancy types, you have things like houses in multiple occupancy (HMOs), and multi-unit freehold blocks. There are specific products in the Buy to Let market to cover these. An HMO has its own set of criteria – these are small bedsits or student accommodation where you may have washing facilities in your room, plus communal areas like a kitchen, toilet and bathrooms. There’s specific licensing required from your local authority for these, as well. So yes, restrictions are definitely in place. 

A landlord licence may also be required with certain local authorities. This is designed to improve the standards of property management in those areas – trying to get rid of slum landlords is the easiest way of saying it. That licensing is key for some areas of the country. 

You may also need a specific mortgage product for these types of accommodation – whether that’s an HMO, or for multi unit freehold blocks, which is a residential house split into separate flats, but all on one freehold title.

A whole other area is operating a property as a holiday let – such as a cottage on the coast or an Airbnb. There are niche lenders for these. There is also serviced accommodation, which is similar to Airbnb. 

Lastly, something that has become more prevalent recently, is renting to housing associations – social housing rental. Again, it’s very specific and not all lenders will look at those. 

What are the potential risks involved in investing in Buy to Let properties?

I think everybody’s seen the programmes on Channel Five about horror tenants. That’s literally what can happen, though. A tenant might trash the place or stop paying the rent. They start playing you off against the local authority and environmental health. A simple process of serving them notice becomes a long, drawn out process through the courts. 

Also, as with any property, the price could fall, or what you were earning as a net profit starts to be pinched. If you stop making the mortgage payments, obviously the risk is that the lender calls in the debt and repossesses the property from you. But that is a process with many steps to it and hopefully it can be sorted out sooner rather than later. 

But forewarned is forearmed – with any sorts of risks with investing in properties, if you have a lot of knowledge, you can limit those risks.

When you’re looking at areas to Buy to Let, do your research on what that area is like. If it’s near schools, logic says it will attract young families or couples planning to have children. You wouldn’t want an HMO in an area for families. Research is key – you want to be servicing the market you’re buying that property for.

Are there any government schemes or support available specifically for Buy to Let investors?

A great support for landlords is NRLA, the National Residential Landlords Association. You have to pay a fee to join them, but they’ve been going for many years. For advice, go to their website – it’s fantastic both for a first time landlord and well seasoned landlords with a portfolio of 50 or more. There will be something there to help you from any angle, including legal or tax information. 

The government also offers some specific schemes, like the boiler upgrade scheme and energy initiatives.  There’s the Great British Insulation Scheme, and the Electric Vehicle Charge Point Scheme where you can get grants from the government. 

If you are looking to convert a property with a specific housing association need in mind, you can get grants to convert the property so that it is fit for those with disabilities. 

How important is property management for Buy to Let mortgages?

I think property management is key. If you have a well managed property, at the end of a tenancy you will quickly attract future tenants because they see the property is clean, tidy, and decorated nicely with no damage. 

Do you want to be hands on as a landlord from that point of view, or do you want to get a property management company involved? If that’s the case, there’s a fee attached to that. It’s normally between 8% and 12% of the rental every month. It means that you, as the landlord, don’t get bothered by a phone call at 2:00am because the boiler’s broken or water is dripping through the ceiling.

With a management company, it’s dealt with by them. You can agree a financial limit with the company, where costs below a certain amount are just dealt with. For anything above that, they have to come with a quote and you sign it off. 

Property management is key because without it, you could quickly get a reputation as a landlord that doesn’t really keep their eye on the ball. You may be able to get headline rent in year one and two, but if that tenant then leaves because they’re fed up with chasing you or the management company is no good, your ability to achieve top rental income will reduce.

What are the consequences of defaulting on a Buy to Let mortgage?

Just like with a residential mortgage, in that situation you are in relatively hot water. If it’s in your personal name, your credit file will be impacted very quickly. For a limited company, the company credit file will be impacted. 

If you default and continue to default, the lender will instruct a receiver to take over the management of the property and look to sell it on your behalf to recoup the debt for the lender. If there is any money left, you will get that after the receiver fees. 

If you default but then you bring the payments back up to date, your property is safe but you  will still have an impact on your credit file. When remortgaging, the interest rates you can get will be a lot higher because of your impaired credit file. That’s not to say that you won’t be able to get a mortgage – you will, but at a higher interest rate until such time as your credit file is repaired.

How would I add additional properties to an existing Buy to Let portfolio?

If you buy your property via a limited company, some lenders set a maximum of four properties that they will lend on. Other lenders are happy for you to buy up to ten properties and borrow with them. Some lend over and above that, with a threshold of £3 million or £5 million in total lending. 

As the portfolio gets larger, lenders look at the leveraging. They consider every property in the portfolio to see if your monthly rental income has dropped against the mortgage payments, or whether the property price has fallen in that area for whatever reason.

There may be an issue there if it’s over leveraged – which means it’s gone above the 75% Loan to Value due to property pricing. They look at the overall cost of the portfolio and its performance. 

To get a mortgage as a limited company, lenders ask you for your SA302s and tax year overviews. If the property company has been running for a few years, they will look at the full accounts. They’ll also want to understand any other income in the background and whether it covers the mortgage payments. 

They just want peace of mind that if the rent were to fall away for whatever reason, you have an income to cover the mortgage payments.

As you become successful at this and you build up that portfolio, lenders will always look at the properties to understand what’s happening with them. If you are going for something specific like an HMO, they will check you have the appropriate licences in place. If not, they will wait until you have them before lending.

What steps should a first time Buy to Let investor take before applying for a mortgage? 

Look at joining NRLA for information. And speak to a broker first and foremost to get an idea of what you can borrow. 

They will ask you a simple question: is it going to be in your name or a limited company? If it’s in a limited company there may be tax efficiencies, but you need to speak to an accountant. 

Once you understand which route you’re going down, the next step is your business plan. Some people fall into being a landlord, but it’s best to have a plan, know your numbers and understand your threshold in the area where you’re looking. What is the maximum rental income for a three bedroom property in Wakefield? 

If you’re going to go for niche markets like HMOs, understand that market. Learn about your area, if you need to have a licence and what sort of costs are going to be involved. 

To stand out from another HMO landlord, what do you need to do? Do you need to go over and above with decoration or appliances? If you’re going to spend money on that property, you want to understand if that will achieve a higher rent – or will it hit a ceiling? We can help you make sure you’ve considered all the key factors. 

Your property may be repossessed if you do not keep up with your mortgage repayments.

The Financial Conduct Authority does not regulate most Buy to Let Mortgages.