A Buy to Let mortgage refers to a loan that is used to purchase property in order to let it out. A buy to let mortgage is typically interest-only, and available up to 85 per cent of the value of the investment property. A single buy to let loan may be used to purchase more than one property.
A buy-to-let mortgage, also known as an investment mortgage, is designed for borrowers who want to buy a property to let out to a third party (e.g. tenants). The amount that the buy to let landlord receives in rent may be over and above the mortgage payments and will help to offset the management and maintenance costs of the property.
Over the past few years, more and more people have taken to investing in buy to let property as a long-term opportunity to make profitable returns, as well as a way of securing finance for their retirement plans.
Buying a property to let can benefit the private landlord in two ways. Firstly, it can provide a stream of income. Secondly, many Buy to Let landlords purchase property because of the potential for long-term accumulation of capital growth. This section provides guidance about how to take out a successful buy to let mortgage, the pitfalls that may occur and the knowledge needed to avoid them.
In the past, a landlord wishing to take out a mortgage on a property for the purpose of producing an income would be viewed by a lender as having a commercial interest. This used to result in higher rates of interest for borrowers seeking to buy to let. However, recent lender policy following general housing market expert consensus, is that the private rental sector should be encouraged to grow as much as possible. The lending criteria have been changed, and interest rates for private investors in property have been lowered under a new buy to let initiative. Buy to let loans are typically available at slightly higher rates than standard owner-occupier mortgage deals.
Before taking into account all of the costs of letting, which can soon add up, the gross return should be between 7 per cent and 10 per cent. Capital appreciation is likely to match, if not exceed, inflation rates for the near future. The rents that you make should be approximately 130 per cent of the monthly mortgage repayment as a minimum, in order to cover all of the potential costs.
The advantages of taking on a registered letting agent are numerous. They will know how to communicate with lenders. Furthermore, they will know the market in the area in which you are buying. This can be essential, because the type of property you buy may determine how much you can rent it for and the type of people who rent it. Knowing how high the demand for properties of each type are is part of a letting agent’s job. A letting agent may also be able to advise you on the standard of decoration necessary, including what fittings and furniture you need to provide. The letting agent should be able to find respectful tenants who pay on time every month. Furthermore, if you place your property in the hands of an experienced professional letting agent, lenders are more likely to approve your application.
If you do decide to use a letting agent to manage your property, it is almost certainly advisable to choose one who is registered with ARLA (the Association of Residential Letting Agents.)
The first step in the buy to let ladder is finding an appropriate property. Once a property of appropriate price has been found, it is necessary to assess whether it has the potential to be let out, how much can be expected in terms of rental yield (dependant upon a variety of national and local factors) and whether the property needs new fixtures and fittings in order to attract the right type of tenants. Once you have found a property for sale, you will need to arrange a buy to let mortgage.
A Buy to let mortgage does not differ massively from a standard private owner-occupier mortgage. Borrowers taking out Buy to let mortgages are subject to standard checks.
If you have an ARLA member agent responsible for letting and managing your property, the rents achievable from your investment property may be able to be taken into account when the lender assesses your situation. The criteria do, however, vary from lender to lender.
Generally speaking, most lenders will require your rental income to be 125 per cent of mortgage repayments. For example, if you were paying off a buy to let loan of £500 per month, you would need to be clearing rent of £625.
Most lenders will expect that the rental income on the property will exceed the mortgage repayments. The level at which this becomes acceptable varies between lenders. Some lenders will consider the rental income, whereas others will only be interested in your standard income.
Fixed rate buy to let mortgages allow the borrower to pay a set rate for a fixed period, usually between two and ten years. The advantage of a fixed rate mortgage when buying to let is that you can calculate exactly what your future costs are going to be. It is certainly worth being aware of the penalties for early repayment that are included in some buy to let mortgages. Some mortgage lenders offer a flexible deal that allows you to overpay, underpay and even take payment holidays without any penalty fee being incurred. There are an enormous variety of different loans on the market, generally extending for between five and 45 years and between £15,000 and £1 million.
When looking for a buy to let mortgage deal it is worth looking at both the headline interest rate and the APR (Annual Percentage Rate), which should include all set up fees and administrative costs. You should be thinking about flexibility: does the loan allow early repayment and what will happen if you face a long void period. You should also be aware of the possibilities of remortgaging. It is common practise amongst landlords to free up capital by remortgaging and using the savings to help buy further properties.
Although in theory a buy to let loan is secure because of the rental yield and the capital value stored in the property, in reality the higher the risk you represent to the lender the higher the interest rate is likely to be.
Some lenders may offer other buy to let mortgage loans, but this list details some of the most common types:
- Fixed Rate Buy to Let Mortgage
- Variable Rate Buy to Let Mortgage
- Capped Buy to Let Mortgage
- Minimum Status Buy to Let Mortgage
- UK Limited Company Buy to Let Mortgage
- Non Resident Buy to Let Mortgage
- Self Certified Buy to Let Mortgage
Firstly, it is imperative to not allow personal taste to cloud your judgement. The first question should be: will a range of people who live in this area want to rent this property out? The property is not for you to live in; it is for tenants to rent for a fixed period.
Talking to a letting agent will allow you to gain an appreciation of the area in which you intend to buy. They will know the specifics of the market, including which properties are in high demand. A general rule of thumb (although this may vary from area to area) is that purchasing a smaller property in a town (such as a one-bedroom or studio flat, or two-bedroom apartment) is almost always a sound investment. This does of course vary from property to property.
Buying to let for the student market is certainly a viable option in university towns. However, student rents are generally lower, and it may be worth bearing in mind the condition of the property after years of student occupancy.
Furnishings should be neutral. Because you like a certain colour does not mean someone else will. Walls should be kept to magnolia or white, making them easier to paint over at the end of each tenancy. There is a fine balance to be struck between the cost of furnishings and their attractiveness, but they should be of a sufficiently high quality to provide a decent rental yield.
It is also worth bearing in mind exactly what a tenant will want, or what he or she will demand. This could include anything from a microwave to a second phone line for the Internet. Standard requests from tenants may vary from area to area, and students in particular may have different requests to general tenants.
Specific furnishing may make a house more valuable and attractive to tenants. One example of this is wooden floors. However, it is always worth remembering the cost of upkeep before outlaying too much money. A letting agent should be able to provide you with an inventory.
This is a good reason why a local letting agent can be extremely useful. It is essential to fix rates realistically: in line with other properties in the area of a similar type and value. One factor is always worth remembering: it is better to have a low rental yield than none at all. One of the greatest potential pitfalls of buying to let is periods when your property is vacant, although at some points (such as between tenants and during periods of refurbishment) these may be necessary.
Rental rates can also be subject to fluctuations depending on the time of year. For instance, the end of the summer is traditionally a peak period as graduates move into new dwellings, families settle before sending children to school and students look for accommodation.
When making any kind of investment, it is always a good idea to consider the worst-case scenario. When it comes to a buy-to-let property, a bad situation would occur if it proved impossible to find a tenant for an indeterminate period. In this instance, the landlord would be paying not only the loan but also the agency fees and maintenance costs, without seeing any return on the investment.
However, if you budget carefully, have chosen a property wisely and set the rent at an appropriate rate, there is no reason at all why this should be a problem. Buying a property to let opens up a considerable number of costs, including legal fees, survey costs, and stamp duty. Maintenance, utility contracts and refurbishment can soon add to these. It is worth totalling up all potential costs and deciding in advance whether you have the budget to cover them, also factoring in a rise in mortgage rates.
Potential problems with tenants are manifold. Some will refuse to pay rent, and others will refuse to move out at the end of their tenancy. For this reason, ensuring that you have a legally binding contract in the form of a tenancy agreement is vital. A solicitor or a managing agent may prepare these. Writing in a six-month break clause can be a good idea, after which either you or the tenant can give between one and two months notice.
Some experienced property investors prefer to run their properties on shorter tenancies, although these are more common in last cities and financial centres. Although this can provide higher rents, it can also leave the landlord at a greater risk.
When it comes to letting a property, it is classed as a business asset and you are required to pay tax on the income. Brokers generally advise borrowers looking to buy to let to take out interest-only loans as opposed to repayment loans, because all interest on your buy to let mortgage can be offset against tax. How you handle the purchase of your buy to let property depends on how you perceive the investment. If you are looking for an income, it may be worth putting down a larger deposit on your mortgage in order for mortgage payments to take up a smaller part of the monthly rent.
As a buy to let landlord, you can also offset some of your costs against your tax. The standard rule is that anything that is not classed as improvements to the property can qualify for tax relief. This can include insurance, cleaning and gardening services, commission for letting agents, and various other management expenses. You cannot claim for the initial cost of furnishing a property, but when you do furnish somewhere yourself you are entitled to a wear and tear allowance of approximately 10 per cent of annual rent.
As a private landlord, it is up to you to keep accurate records of what rent you have received and when. All income from your property must be included in your self-assessment tax return. This can be recorded in Land & Property supplementary pages, available from your tax office.
In terms of tax on capital gains as opposed to income, when you come to sell a buy to let property any profits that you make are subject to Capital Gains Tax (CGT) at your highest level of income tax. There are possible ways in which to mitigate this liability. Buy to let landlords should be aware that the property will be included in their estate when they die, potentially leaving it susceptible to inheritance tax.
Should you come to sell your buy to let property, you may be liable to pay Capital Gains Tax (CGT.) However, you are not charged CGT on the £8,500 of annual profit. Furthermore, if you are married and the property is in joint names, you may use both of your CGT allowances when selling. You can costs incurred in buying and selling from your overall profit.
As the owner of a buy to let property, you may also be eligible for something called CGT taper relief. If you sell the property within three years, you will incur CGT on 100 per cent of all profits (less buying and selling costs.) However, should you keep the property for over three years, the amount that you pay begins to be reduced by 5 per cent per annum. This comes down to 60 per cent after ten years or more.
In theory, it is possible to buy a property to let without a letting agent; you are not legally obligated to have an agent. However, agents will deal with the tenancy agreement, the tenants’ references and any day-to-day administrative problems that might occur. Unless you are experienced, it is highly likely that you will benefit from the expertise of a letting agent.
If you do decide to take on a letting agent, it is almost certainly advisable to choose one who is a member of ARLA (the Association of Residential Letting Agents.)
Following your acquisition, your letting agent will find and introduce tenants, as well as screening their references to make sure they are suitable. The letting agent will also provide the necessary tenancy agreements and advise you on an inventory of what to provide with the house. They should arrange condition reports and make sure that the tenants have made changes to the utility bill accounts and the Council Tax. The letting agent will also collect the rent and pay the balance into the landlord’s account.
A letting agent should also regularly inspect the property and recommend and oversee any necessary re-decoration or repair.
It is possible to get insurance cover that protects landlords in the event of a tenant defaulting on their rent. This insurance should also cover any additional legal costs beyond the normal buildings and contents insurance.
Are there lots of hidden costs with buy to let investment property?
Although the tenant is responsible for the interior costs of the house such as the utility accounts, the Council Tax and the TV licence, if you have a vacant period you will incur those costs. Furthermore, you should bear in mind the costs of keeping a property at a marketable level.
General expenses include the Letting Agent’s commission and management fees. Before signing with an agent make sure that you know exactly how much you will be paying them, and whether you will incur fees in the event of defaulting tenants etc.
Managing a buy to let property always ends up costing more than just the mortgage repayments. It is generally advised that you should be achieving a gross rent of between 125 and 150 per cent of interest-only mortgage repayments. This will cover your costs of buying to let.
DO Seek the advice of a letting agent who understands the local market.
DO Budget for every eventuality. Make sure that the gross rent will cover all your costs and borrowings. Also, be aware that void periods when the dwelling is empty are a possibility and factor them in.
DO Make sure that your buy to let property is furnished to a high enough standard to attract the best tenants. This includes kitchens and bathrooms, both of which are essential to letting out a house.
DO Maintain the high standard of repair by managing your property well. Be aware of when tenants are looking to move out, and make sure you repair any problems quickly in order to avoid empty periods.
DO Make sure that your letting agent is registered with ARLA.
DON’T Let your personal tastes affect your choice of property. I is essential that your property meets all market requirements and is attractive to a wide range of people who live in the surrounding area.
DON’T Purchase a property that has large maintenance requirements, particularly if it does not add to the property’s rental attraction. Anything that constantly costs money to maintain must be considered carefully.
DON’T Be fooled into thinking that running a buy to let property will be east. Being a private landlord is a time-consuming task, and tenants need a management service on call constantly.
DON’T Try to write a tenancy agreement yourself, unless you are very experienced. It is necessary to provide an inventory and condition report before a tenant moves in.
DON’T Furnish your buy to let property with cheap second hand furniture. As well as being unattractive to many tenants, it is possible that this type of furnishing will contravene some legislation.