Some people buy to let with the hope that the property prices will increase, with rental income covering their costs until they sell the property at a profit. Others to buy to let to generate some extra income.
A recent report of the Office for National Statistics shows that the average monthly rent in Greater London between April 2020 and March 2021 was £1430. In some areas, the average monthly rents were exceptionally high.
You will have to secure a mortgage if you are not a cash buyer. However, when you purchase a property to rent it out and generate rental income, you cannot do it with a residential mortgage. You will need to secure a buy to let mortgage.
This article, which is part of a series of articles on the conveyancing process, takes a closer look at how buy to let mortgages work. It also discusses the general conditions mortgage lenders will require to give you the loan, how to choose the right property for buy to let, and remortgaging with a buy to let mortgage.
What is a buy to let mortgage?
Buy to let mortgages are specifically designed mortgage products that allow you to buy a home to rent it out. Conventional mortgages do not normally allow it.
Mortgage lenders have different assessment criteria (which we will get to shortly) for borrowers buying a property as an investment to rent it out rather than to live in it.
How do buy to let mortgages work?
Buy to let mortgages are similar to conventional or residential mortgages, with a few key differences.
How much can you borrow on a buy to let mortgage?
The amount you can borrow on a buy to let mortgage will be based on your deposit, personal and financial circumstances, expected rental income the property can generate, and how much the mortgage will cost you. Further, many lenders have increased the rental income requirement under stricter rules imposed in 2016 by the Prudential Regulation Authority.
Typically, mortgage lenders require the expected rental income to be at least 125% to 145% of your monthly interest payments.
How much deposit with buy to let mortgage?
The Loan to Value Ratio (LTV) for Buy to let mortgages is generally lower (the maximum loan to value ratio for buy to let mortgages is around 75% of the property value).
This means that borrowers need to put down a higher deposit as compared to conventional mortgages. Generally, the minimum deposit requirement in buy to let mortgages is 25% of the property value.
Buy to let mortgages types
Further, buy to let mortgages are often interest-only type of mortgages (the reason is explained below). However, you can also buy to let repayment mortgages.
You can read up about interest only and repayment mortgages in in our article on types of mortgage.
Buy to let interest only mortgage
Essentially, buy to let interest only mortgage mean first you will have to pay off the interest without making any repayments towards the principal amount.
Once the interest is paid off, your mortgage repayment starts going towards capital payments. So borrowers may initially feel that they are not even making a dent in their total debt.
Most people choose interest-only mortgage for buy to let as monthly repayments are lower, maximising the rental income and increasing borrowing potential.
However, towards the end of the mortgage term, you may not own the property due to this. So you will either need to sell the property (and pay Capital Gains Tax when you sell) or be ready to buy it outright (which will require you to pay stamp duty land tax).
Buy to let repayment mortgage
Buy to let repayment mortgages are structured so that your mortgage payment goes towards both interest payment and towards the capital amount.
Generally, investors don’t prefer repayment mortgages for buy to let as monthly repayments are higher. This restricts the profit you can generate, as most of it will go towards mortgage repayments. However, towards the end of the term, you will most likely own the property, as long as you keep up the mortgage payments.
The bottom line is that your decision to go with a buy to let interest only mortgage or a buy to let repayment mortgage for should be based on your aims from taking on this venture.
Which one is best for you?
If you want to generate extra income, an interest only buy to let mortgage may be the preferable choice.
On the other hand, if you want to invest in a property to build your assets, a repayment buy to let mortgage will be better.
You can choose to hire a mortgage broker for mortgage advice and to help you secure a mortgage. However, you should read our article on mortgage brokers before engaging one, as their contracts can be tricky.
Buy to let mortgage requirements
Buy to let mortgages are for both seasoned investors and new landlords.
All mortgage lenders have different assessment criteria for buy to let mortgages. Generally, the assessment criteria consist of:
- Age range (usually you should be younger than 75 when the term ends)
- A minimum monthly income requirement
- A limit on the number of buy to let mortgages you have can have; and
- Affordability checks
Choosing the right property for buy to let
While choosing a property, you need to keep three things in your mind: your potential tenants, locations, and rental yield.
It would be wise to focus on your potential tenants to decide whether a property is right for buy to let. For example, students, families with children, and young professionals have their particular requirements for the kind of home they want to live in as well as different considerations for its’ location.
As you will become a landlord, you need to think about how you will manage the property. Ideally, if you consider doing it yourself, you should be close enough to the property, so you don’t have to travel a lot.
On the other hand, if you use a letting agent, while you incur an additional cost, you can expand your options and search properties in areas with a higher demand for rental property.
The rental yield can help you compare the potential profitability of properties. Calculating it is simple:
- First, work out your cost (such as mortgage, stamp duty, property survey, insurance, repairs, estate agent fees, letting agent fees, local authority searches, and conveyancing fees).
- Then calculate how much rental income the property can potentially generate.
- Subtract the potential annual rent by your cost.
- Divide the result by the value of the property; and
- Then multiply the result by 100 (to give you the rental yield as a percentage)
By thinking along these lines, you are more likely to find a suitable property for buy to let.
Remortgaging on a buy to let
You can find various mortgage deals with buy to let mortgages, such as fixed interest rate or tracker deals. However, usually these mortgage deals are for an initial period after which you revert to the lender’s standard variable rate. At that point when your mortgage deal is about to expire, you will want to remortgage.
Most remortgage applications are accepted without any problems.
The most common reason for reject of remortgage applications is failing the “stress test”. Lenders make these checks to assess if you can afford the mortgage if interest rates were significantly higher.
Another reason includes having a low credit score and issues such as County Court Judgment.
A few last words on buy to let mortgages
Buy to let can be an excellent way to increase your income or slowly build assets.
If you are not a cash buyer, you will need a buy to let mortgage as residential mortgages don’t normally allow you to purchase a home if you don’t plan on living in it.
You may also have to pay stamp duty land tax when you purchase a buy to let properties, as well as taxes on the rental income the property generates. So you need to know how those are worked out.
Further, as a landlord, you will have certain rights and responsibilities towards your tenant(s). If you use an agent to manage the property (which can be useful), you will incur additional costs.
You can read about landlord rights and responsibilities and how to work out your taxes if you rent property in our article, Buy to let explained.