Buy-to-let mortgage guide
Buy-to-let mortgage guide
There are many different types of buy-to-let mortgages available, such as interest-only buy-to-let mortgages to repayment mortgages. You may choose to purchase through a company, in which case you would need to take out a limited company buy-to-let mortgage. Mortgage availability and criteria also differs if you are based overseas, so your geographical location should be considered before applying for certain mortgages. Our buy-to-let mortgage guide covers all of your most frequently asked questions.
- What is a buy to let mortgage?
- How to qualify for a buy-to-let mortgage
- Available buy-to-let mortgage options
- Buy to let mortgage through a company
- Can an overseas investor get a buy-to-let mortgage?
- What is loan to value?
- What is an interest-only mortgage?
- Interest-only vs repayment mortgage
- Types of mortgage
- What is rental guarantee insurance?
- How can I get rental guarantee insurance?
The first thing you may be wondering though, is what is a buy-to-let mortgage, and how does it differ from a regular residential mortgage?
What is a buy to let mortgage?
In truth, buy-to-let mortgages are not really that different from residential mortgages, but there are a few important things you would need to be aware of. When we talk about ordinary, residential mortgages, we mean mortgages people take out if they wish to live in the property themselves. Buy-to-let mortgages are taken out if you wish to rent out the property to people other than close family members.
Buy-to-let mortgages require you to have a larger deposit, usually at least 25% of the property’s value. Interest rates and other fees associated with buy to let mortgages also tend to be higher.
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Most buy-to-let mortgages are available on an interest-only basis, where you would only be paying off the interest for the duration of the term, and then the full amount is payable afterwards. They are also not regulated by the Financial Conduct Authority unless you wish to let the property to a close family member.
How to qualify for a buy-to-let mortgage
With a normal residential mortgage, lenders would assess your salary and outgoings before deciding upon the amount you can borrow. This differs from a buy-to-let mortgage, which hinges on different factors such as the rental income you expect to generate from the property.
It is a bit more difficult to qualify for a buy-to-let mortgage as the Bank of England tries to cool the buy to let market. This means that potential landlords will be subject to strict affordability tests. How much you can borrow through a buy to let mortgage is based on the Interest Cover Ratio (ICR). This is how much rental income you expect to receive and how this will cover mortgage repayments. You will typically need to be receiving around 125 – 145% of your mortgage costs in rental payments.
Lenders will also consider how many properties you have in your portfolio, as the more properties you own the more difficult it is to obtain finance. If you own over 4 properties, you are considered a “portfolio landlord” and you will be subject to stricter regulations.
Some lenders will stipulate that you can only have a certain number of properties in your portfolio. Others base their decision on the loan to value ratio, and others demand that the ICR for every property be above a certain percentage.
Most buy to let mortgage lenders would require you to be earning your own income too, this minimises their risk as you still have a possible way to afford mortgage repayments.
Available Buy-to-let mortgage options
Most high street banks will offer buy-to-let mortgages. You can also use the service of a mortgage broker who will help you arrange a mortgage that will meet your requirements.
There are websites such as Compare the Market which will compare various mortgage options, although there may be hidden charges or caveats that are not immediately obvious on first sight.
Where can I get a buy-to-let mortgage from?
Most large banks and specialist lenders offer buy-to-let mortgages. You can also discuss your requirements with a mortgage broker or use a price comparison website to get a better understanding of what is available and for what cost. When using price comparison websites, exercise caution as there may be hidden costs or terms and conditions.
Buy to let mortages for first time buyers
If you are a first-time buyer and you want to immediately rent out the first property you own, things are a bit different.
It is possible for first-time buyers to obtain a buy to let mortgage, but you may need a larger deposit. There may also be fewer mortgage options available to you. With regards to stamp duty, you will not benefit from first-time buyer’s stamp duty relief, but you will avoid paying the additional 3% surcharge levied on buy to let investors.
You may find it difficult to obtain another mortgage as lenders will examine the debt owed on your existing buy to let mortgage, and you will have to pay a surcharge for any other property you end up buying.
How to get a buy to let mortgage through a company
If you are wondering if a limited company can take out a mortgage, the answer is yes. Many investors decide to purchase property through a limited company, and there are buy-to-let mortgage options available for this too.
If you set up a company for the sole purpose of owning property, the company is sometimes referred to as a Special Purpose Vehicle (SPV). When financial institutions look at lending, they would generally take into consideration the financial standing of the company.
When buying a property through a limited company you generally need to provide two years of profitable trading history and a good balance sheet to be given a mortgage.
That can be a problem for SPVs as they have no financial history at all. What frequently happens is that a lender would require a personal guarantee from each company director. This means that if the company is unable to honour its debts, the company directors are personally liable and can be chased for payment.
The lender will assess the company directors and their own ability to pay the mortgage, so the affordability will be dependent on your personal financial standing.
Depending on what you want to use the money for, there can be some tax benefits of investing in property through a limited company. For a list of lenders for buy to let mortgages available to companies, see the Money.co.uk list.
Can an overseas investor get a buy to let mortgage?
The UK property market performs well, and property is one of the strongest asset classes. It is not surprising that many people from all over the world are wanting to invest.
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Perhaps you are living overseas and want to invest in the UK property market but are unsure how to obtain a mortgage. The truth is, there are UK buy to let mortgages available to non-UK residents. Generally, the mortgage availability for non-UK residents is more restricted and more stringent checks are put in place to ensure that the rental coverage is 125% of the mortgage payment.
As property is something people put a large amount of money into, identity checks are needed, as are checked to see where the money is coming from. If you are a non-EU citizen looking to invest in UK property, these checks are even more thorough to minimise lender risk.
What is loan to value?
The loan to value ratio is an assessment of risk that lenders would consider before approving a mortgage. It represents how much you need to borrow vs the amount the property is worth. For example, if you buy a house for £200,000 and put down a £40,000 down payment and need a mortgage for the remaining £160,000, it will have a loan to value ratio of 80%.
Generally, the higher the ratio, the riskier the loan. Lower loan to value ratios can obtain better interest rates, especially at 80% or below.
What is a typical loan to value ratio for buy to let property?
For landlords wanting to obtain a mortgage for buy to let property, the lending terms are generally stricter. Prior to Coronavirus, it was possible to obtain a higher LTV mortgage. Now, landlords will need a deposit of at least 20%, and the loan to value ratio will need to be 80% or lower.
Over time, banks have gotten stricter on their lending, especially during the Coronavirus pandemic. Generally, the maximum loan to value ratio for a buy to let mortgage is 80%.
For foreign nationals, overseas investors or expats, the loan to value ratio would be lower still, at around 60%, so you might need a larger deposit.
What is an interest-only mortgage?
Nearly one in five homeowners have financed their property through an interest-only mortgage. What is an interest-only mortgage? An interest only mortgage means that you only pay off the interest on the loan, not the balance. At the end of the term, which is usually 25 years, you will still owe the amount you borrowed, but your monthly payments over the term will be smaller.
What are the benefits of interest-only mortgages?
Many buy to let landlords finance their property purchases through interest-only mortgages. There are a few key benefits to investing this way. Firstly, it allows investors more flexibility with their finances. Your overheads are lower as the monthly repayments are lower, and they are often covered by rental income anyway. This allows you to invest additional capital in other properties or investment vehicles, thus diversifying your portfolio.
Buy-to-let interest-only mortgages can also be beneficial if you are looking to expand your property portfolio at some point in the future. Some landlords release equity by taking advantage of rising property prices. They do this by re-mortgaging current properties and releasing equity, this is sometimes known as leveraging.
Of course, you need to be careful when leveraging property. You would need to seek out areas of high capital growth so there is the possibility your property will increase in value. If you feel like you need further guidance in finding those areas of high capital growth, contact an investment consultant at One Touch Property today who will be able to suggest areas with potential.
What are the risks of interest only mortgages?
Although many buy-to-let landlords choose to take out an interest only mortgage, there can be some risks involved. You are still liable to pay off the mortgage at the end of the term. If you choose to sell your property but your house has gone down in value, you could be left with negative equity as you will still owe the amount you originally bought the house for.
You will also need to make plans for how you will pay off the mortgage once the term has expired. If you do not have the money to pay for the property, it may get repossessed and you could lose your home, despite having paid interest for the last 25 years.
Interest-only vs repayment mortgage
Most buy-to-let mortgages are available on an interest-only basis. Buy-to-let mortgages are sometimes available on a repayment basis, where you pay off part of the mortgage each month, as well as the interest. Having a repayment mortgage means that your monthly outgoings will be higher, but at the end of the term you will owe less money.
How much interest will I pay on my mortgage?
The amount of interest you will pay on your mortgage depends on the type of mortgage you have.
Types of mortgage
Generally, buy-to-let mortgages are interest only. Although repayment mortgages are available where you pay off the interest together with the capital.
Variable rate mortgages can move up and down over time. This is mainly due to changes in the UK’s economy, although other factors can affect this too. There are three types of variable rate mortgages: standard variable rate, fixed rate, and tracker rate.
A tracker mortgage would generally be in line with an economic indicator, but not the same as the base rate. The benefits of a tracker mortgage are that if interest rates fall, so will mortgage repayments. On the other side, if interest rates increase, so will mortgage payments.
Standard Variable Rate Mortgage
These rates are usually fixed by the lender. They tend to follow the Bank of England’s base rate movements but can be between two to five percentage points above the base rate. Rates usually vary quite a lot between lenders.
Most homeowners find themselves on a Standard Variable Rate Mortgage. They are often seen as more expensive and riskier, as banks can change their rates at any point. However, there is no penalty for repaying the mortgage at any point and if interest rates drop, its likely your rate will too.
Fixed Rate Mortgage
The interest you would pay is fixed throughout the term. The benefit is certainty, as you will always know how much you must pay. Also, if interest rates go up, you will not have to pay more. However, you will not stand to benefit if interest rates decrease.
What is a Help to Buy Mortgage?
The Help to Buy scheme is as a government initiative to encourage home ownership. Under the scheme, the government will lend the buyer 20% (40% if in London), of the cost of a newly built home. It would mean that you would need to pay a 5% deposit and arrange a mortgage to make up the rest. Interest is not chargeable on the 20% loan for the first five years of home ownership.
If I move out of main residence, do I have to inform my lender?
If you financed your buy to let property with a buy to let mortgage, you may run into problems if you decide to move into that property. This is because a buy to let mortgage is specifically designed for landlords, and not for owner-occupiers.
Moving into your buy to let property may invalidate your mortgage and you may be required to pay it all back. As we have mentioned before, buy to let mortgages are not regulated by the FCA unless you intend to rent the property to a family member, or you wish to live in it in future.
If you choose to live in the buy to let property but you have a buy to let mortgage the lender would need to be covered by FCA regulation and would need to alter the terms of your agreement.
If you wish to occupy your buy to let property, you will need to contact your lender as soon as possible and try to change your mortgage agreement with them.
Can my home get repossessed?
As with all mortgages, if you do not keep up with your payments then your home can be repossessed. That is why it is important to set out what you can afford before you choose an investment, and take out rental income insurance to cover you for any losses in rental payments you might encounter. Next, we will explain exactly what rental guarantee insurance is, and why it is beneficial for landlords to have this type of insurance.
What is rental guarantee insurance?
There is always a risk that tenants will default on rental payments. This can happen to any landlord, regardless of how stringent the application process is and how thorough the checks are. You may want to take out insurance against the loss of rental income to protect yourself as a landlord.
Loss of rental income will cause problems for the landlord who still needs to pay their mortgage and additional bills such as council tax or utilities. This is where having rental guarantee insurance (sometimes known as rental protection insurance), is important.
A rental guarantee insurance policy will cover missed rental payments, although there may be limitations so landlords will need to read the small print. You can buy cover for six – twelve months depending on the length of the tenancy agreement, and it can usually cover a certain level of rental loss until the tenant is evicted.
In general, you cannot make a claim within 90 days of taking out a policy. It is best to get rental guarantee insurance sorted as soon as possible rather than when you notice things going awry with your tenant.
How can I get rental guarantee insurance?
The RLA offers Rentguard Insurance which will cover landlords for rental arrears. The insurance covers rental properties of all sizes and even extends to student and holiday lets. The policy covers landlords for £3,000 per month to a maximum of £18,000 or for six months (whichever is less). It also covers costs for advisors should the landlord need to act against the tenant.
Other UK insurance providers will also offer similar rental guarantee insurance products. You will need to research them and shopping around to get the coverage that suits you.
Arranging a mortgage can take a lot of work so it is good to know the basics of what a buy to let mortgage would entail and how to qualify for one. How you purchase your property will also impact mortgage availability, as there are different mortgage options available for limited companies compared to an individual. Our guide gives an outline as to what to expect when applying for a buy-to-let mortgage, but it is also worthwhile exploring these options further. There are other commercial property investments that do not require a mortgage. Care home investment come with a long term commercial lease between 10 – 25 years so rental insurance is not required. As an investor, it may be worth exploring those options by downloading the investment property guide.
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