Mastering Buy to Let Mortgages
Your home may be repossessed if you do not keep up repayments on your mortgage.
The Financial Conduct Authority does not regulate most Buy to Let Mortgages.
All information was accurate at the time of publication.
1st July 2024
During my 15 year career giving mortgage advice, I've guided hundreds through Buy to Let applications. They can be a fantastic way to diversify your investment portfolio, but it's crucial to get financial advice before diving in. If you need an introduction to a financial advisor, do let me know.
Property investment's appeal lies in its tangibility – you own a real piece of land and brick-and-mortar. The process is relatively straightforward: you acquire a property, rent it out, and ideally, the rental income covers your mortgage payment. It's a well-established path with plenty of experienced advisors available to guide you. Throughout this blog, I'll answer common Buy to Let (BTL) mortgage questions, aiming to boost your confidence as you consider property investment.
How does a Buy to Let mortgage differ to a residential mortgage?
While residential mortgages offer a familiar path to homeownership, Buy to Let mortgages come with some key differences. Here's a breakdown to keep in mind:
Regulation: Residential mortgages are regulated by the Financial Conduct Authority (FCA), offering you certain protections. Buy to Let mortgages typically fall outside these regulations.
Occupancy: A residential mortgage allows you or a family member to live in the property. Buy to Let mortgages, with some exceptions, do not.
Deposit: Be prepared for a bigger down payment. Residential mortgages often allow a minimum 5% deposit, while Buy to Let mortgages typically require at least 25% (some lenders offer 20% with stricter criteria).
Repayment Structure: Most residential mortgages are repayment mortgages, where you pay off the entire loan by the end of the term. Buy to Let mortgages are more commonly interest-only, meaning you only pay the interest on the loan throughout the term. The full balance will still be outstanding at the end, requiring you to sell the property to repay it.
Capital Gains Tax: Selling a residential property usually incurs no capital gains tax (CGT). However, with Buy to Let properties, you'll likely pay CGT on any profit made when you sell.
Do I need to own my home to have a Buy to Let?
While owning your own home is often preferred by lenders for Buy-to-Let applications, there are some exceptions. If you already own a rental property and you are looking to remortgage your existing rental property, several lenders are happy to consider your application based on its usual underwriting criteria, without needing you to own your residence. Additionally, some lenders are open to applicants who live in a property owned by their partner. This can be advantageous, particularly if your partner falls into a higher tax bracket than you.
Can I buy a rental property as a first time buyer (FTB)?
Similar to the previous question, while owning your own home can be a requirement for some buy-to-let mortgages, the good news is there are lenders who take a more comprehensive approach. These lenders will consider the rental income of the property you're looking to buy and assess your overall financial picture, including income and expenses. This means even if you're a first-time buyer (FTB) renting or living with family, you might still qualify for a buy-to-let mortgage, provided your finances demonstrate you can comfortably manage both the rental property and your current living situation.
How do the lenders decide how much they are able to lend?
The borrowing amount varies by lender. As we discussed earlier, some lenders take a more holistic approach, considering your overall financial picture. As long as you demonstrate comfortable finances, they might be more flexible with the loan amount.
Most lenders have their own Buy to Let calculators. These tools factor in several aspects: how much you want to borrow, the expected rental income, your personal income, the interest rate and term of the chosen mortgage product. By running these details through their calculator, the lender determines the maximum loan amount they can offer you.
Let's look at an example. Imagine you're buying a Buy to Let property with a projected monthly rent of £1,000 and you're a low-rate taxpayer. According to The Mortgage Works (part of Nationwide), you could potentially borrow up to £213,333. However, if you're a higher-rate taxpayer, the maximum loan amount will decrease to £166,666.
Why can I borrow less as a high rate tax payer?
When determining how much you can borrow for a buy-to-let property, lenders will factor in your tax bracket. As of July 2024, anyone earning above £50,271 falls into the higher rate tax bracket. This is because higher earners pay more tax on their rental income, which reduces their overall profit compared to lower rate taxpayers.
To account for this, lenders use an interest cover ratio (ICR). This ratio shows how much your rental income covers your buy-to-let mortgage interest payments. For instance, The Mortgage Works uses a benchmark of 125% ICR for basic rate taxpayers, meaning your annual rental income should be 125% of your annual mortgage interest. This ratio increases to 160% for higher rate taxpayers and 175% for properties with multiple occupants (HMOs). Interestingly, if you choose to buy your buy-to-let property through a limited company, the ICR goes back down to 125%.
In simpler terms, while a higher income might seem like an advantage, it can limit how much you can borrow on a buy-to-let mortgage due to higher tax obligations. However, purchasing the property through a limited company can help navigate this hurdle.
Should I purchase a BTL through a limited company?
This is quite a difficult question and I’ll write a separate blog on the subject further down the line. Whether to buy a buy-to-let property in your own name or through a limited company can be a complex decision. There are advantages to both approaches, and the best choice depends on your individual circumstances.
One key factor is tax. If you buy in your personal name, you'll pay income tax on the rental income. This might not be ideal for higher-rate taxpayers, as the tax burden can significantly reduce your profits. Limited companies, on the other hand, pay corporation tax on their profits, which can be lower than income tax.
However, there's more to consider than just tax rates. When buying personally, you'll generally find a wider range of lenders with potentially lower fees. Limited companies have fewer lenders and may face higher borrowing costs.
Despite these drawbacks, limited companies offer distinct benefits. They limit your personal liability, meaning you're not responsible for the company's debts beyond your investment. Additionally, limited companies offer greater flexibility in managing profits. You can choose how profits are distributed before paying tax, and you can even use them as deposits for future property purchases. Inheritance planning is also simplified, as you can add or remove directors. This could also help by potentially reducing stamp duty liabilities.
It's important to note that selling a property through a limited company incurs corporation tax. In contrast, personal property sales might benefit from capital gains tax allowances.
As I mentioned before, you do need to speak to a tax advisor so you are making the right decision.
Should I have my mortgage on a repayment or interest only basis?
Many landlords opt for interest-only buy-to-let mortgages, but it's a decision that deserves careful consideration. Here's why:
With an interest-only mortgage, your monthly payments cover just the interest on the loan, not the principal amount. This translates to lower monthly costs compared to a repayment mortgage, leaving you with more rental income. This extra cash flow can be used to supplement your income, invest in other areas, or even put towards a deposit on your next buy-to-let property.
Historically, property prices in the UK have tended to rise. Ideally, by the end of your mortgage term, the property value will have increased, allowing you to sell it and repay the remaining mortgage balance while keeping the profit.
However, interest-only mortgages come with downsides. Since you're not chipping away at the mortgage, you'll still owe the full amount at the end of the term. If property values have fallen, you might face a situation where the sale price isn't enough to cover the outstanding mortgage, requiring you to bridge the gap from your own pocket. Additionally, the total interest paid over the life of the loan will be higher compared to a repayment mortgage.
Repayment mortgages, on the other hand, offer the peace of mind of knowing the loan will be fully repaid by the end of the term. This flexibility allows you to sell the property whenever you choose, potentially with a larger profit from the sale due to the repaid capital.
It's important to note that with repayment mortgages, you might be liable for capital gains tax on the portion of the mortgage repaid that exceeds your capital gains tax allowance. Consulting a tax advisor can help you navigate this aspect and make an informed decision.
Should I have a fixed rate for 2 years or 5 years?
When it comes to buy-to-let mortgages, you'll have a variety of fixed-rate options to consider, typically ranging from 2 to 5 years. While variable rates were once a popular choice, the recent rise in the base rate from 0.1% to 5.25% has made fixed rates more attractive due to their budgeting ability.
The ideal fixed-rate term for you depends on your long-term plans for the property. If you view this as a long-term investment, a 5-year fixed rate might be a good fit. This provides stability and spreads remortgaging costs over a longer period.
On the other hand, if you anticipate changes in your circumstances within the next few years, a shorter fixed rate like a 2-year term might offer more flexibility. This could be beneficial if you plan to sell the property soon or expect a future cash injection which you intend to use to reduce the mortgage.
Remember the interest cover ratio (ICR) we discussed earlier? Lenders often show more favorable terms for longer fixed rates. For instance, The Mortgage Works might use a higher stress rate (pay rate + 2% or 5.50%) for a 2-year fixed rate compared to a 5-year fixed rate (pay rate or 4.50%). This translates to potentially better borrowing terms with a longer fixed-rate product.
Can I get a BTL while I’m self-employed?
Most lenders for buy-to-let mortgages are flexible about your employment type, as long as you have a demonstrably steady income. While some lenders may have a minimum threshold of £25,000 per year, how they assess your income can vary depending on whether you're self-employed or a limited company director.
For sole traders, lenders typically use the average of your income over the last two years, and will require tax calculations and year-overviews for that period. Limited company directors will need to provide the last two years' signed accounts. To ensure everything is up-to-date, lenders prefer documentation to be no older than 18 months. This can be a minor hurdle near October, as it might fall just outside that window after the end of the previous tax year.
Understanding how lenders assess your income is crucial, especially if your earnings are close to the higher-rate tax threshold. Once I have your documentation, I can analyse which lenders will consider your income most favourably. In some cases, we might need to target specific lenders to secure the loan amount you require.
Where should I buy a BTL?
Location, Location, Location! Many new landlords choose properties close to home for familiarity and ease of management. This can be a wise strategy, especially for those starting out. As your experience grows, you might consider venturing into up-and-coming areas with higher potential capital appreciation. Locations near hospitals or universities can offer steady demand from professionals and students, respectively. However, student lets can come with potential drawbacks like higher wear and tear or occasional rent arrears.
Northern England presents another option, where property prices tend to be lower, potentially leading to attractive rental yields. Regardless of location, thorough research is key. Visit properties in person to avoid surprises. Consider speaking with local landlords and estate agents for valuable insights into specific areas. This extra legwork can significantly increase your chances of finding the right buy-to-let property for your investment goals.
Can I use my income to borrow more than the lenders calculator allows?
Now we've explored how lenders assess rental income to determine your borrowing limit on a buy-to-let mortgage. But what if your personal income is strong and you can comfortably cover any potential shortfalls in rent? There's good news! Some lenders offer products that consider your overall financial profile, including your salary, to help you borrow more. This approach is called "top slicing," and Accord Mortgages, part of the Yorkshire Building Society, is a lender known for specialising in these types of buy-to-let mortgages.
Using a similar example to The Mortgage Works earlier on, if you were buying a property as a higher rate tax payer, with rental income of £1,000 per month, they could potentially lend you up to £137,931. With Accord, they will ask further questions.
- All applicants party to the mortgage reside at the same residential property
- A single or joint income of £50,000 or more, excluding rental income from BTL properties is required
- No element of the borrowing will be used for capital raising for personal expenditure (repay debts etc.)
- At least one applicant has owned a BTL property for at least a year
- The property being mortgaged has previously been occupied (non - newbuild)
- The mortgage is for a Buy to Let (not a Let to Buy)
As long as the answers to all of the above questions are yes, then they will go through an affordability assessment.
In this example, if you had an income of £70,000, Accord would be able to lend you up to £200,000.
It’s always worth running through the calculations to see if you have more options available.
Can I raise money from my BTL to purchase another BTL?
Ever considered expanding your property portfolio? If you're a homeowner with a buy-to-let property, you might be able to unlock its potential and use it to acquire another rental income stream. As mentioned earlier, most buy-to-let mortgages limit borrowing to 75% of the property value. But what if your property's value has increased?
Let's illustrate this with an example. Imagine you purchased a property for £150,000 with a 75% mortgage, meaning you borrowed £112,500. Since then, thanks to smart renovations and a favourable market, the property's value has risen to £200,000. This means you have equity – the difference between the current value and your mortgage balance.
Through a remortgage, you could potentially increase your borrowing to £150,000. This would pay off your original mortgage and release £37,500 in equity. This freed-up capital could then be used as a deposit for another £150,000 property, allowing you to secure a new buy-to-let mortgage of £112,500. In essence, you'd be turning one property into two, each generating rental income and contributing to your portfolio's growth.
While this is a simplified example that excludes additional costs like legal fees and stamp duty, it demonstrates the potential of equity release to fuel your property investment journey. If you're a landlord considering this approach, feel free to reach out – we'd be happy to explore your options and tailor a strategy to your specific situation.
If you have a buy to let or are looking to start investing in property, the best thing to do is get in touch as early as possible so we can go through your options and make sure you are prepared. I can complete my research and present you with a recommendation personal to you. I'll provide you with a list of documentation that I will need which you can forward on to your accountant, or ask me to deal with your accountant directly.
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