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Buy to Let Mortgages Explained

by | Oct 13, 2022

Home $ How to buy a property $ Buy to Let Mortgages Explained

Introduction

Buy to let mortgages are attractive for landlords looking at property as a form of investment.

This article goes over the finer details of how buy to let mortgages work. From who can sign up for them and how to get approved for a buy to let mortgage. When done right, they can be an incredibly lucrative way of turning a property into a profitable investment.

Wooden house with keys and buy to let documents

What is a buy to let mortgage?

To put it simply, a buy to let mortgage in comparison to a typical residential homeowner mortgage is dedicated for the purpose of being rented out and used as a form of investment.  This includes properties of all ages including new builds and build to rent.

Mortgages are secured loans provided by banks for property purchases. A typical solution if you are not buying in cash outright or using a bridging loan (commonly used at auctions to purchase property).

They are appealing because it allows you to keep less equity in a home but still benefit from the profit that rental income provides as opposed to buying a home outright at once.

The landlord will then use the rental income from the property to pay back the mortgage rather than live in the house and use additional income to pay off the loan. This is the key difference between a normal residential mortgage vs a buy to let.

What is the difference between a buy to let and a let to buy mortgage?

The process involves you turning your current home (which might have a residential mortgage) into a buy to let with a buy to let mortgage and if possible and needed, taking equity out to use for a deposit towards your new residential home. Giving you a buy to let Investment property and a new residential property.

Happy couple moving in to a new home

This is a common approach for people who want to hang onto their current property and potentially leverage the available equity to help with a forward purchase.

This creates an opportunity for someone to let out the original property and buy somewhere else. Hence the term let-to-buy.

Think of the term let to buy as a two-step process and the term buy to let as a business model used by landlords. Many people conflate the two and get confused when attempting to understand let to buy.

What is the purpose of a buy to let mortgage?

What is the purpose of a buy-to-let mortgage? Buy-to-let mortgages are designed to help you buy a property that you intend to rent out to other people, rather than to live in. The amount you can borrow usually depends on the rental income you expect to earn from tenants, although we might consider other income in some circumstances.

Buy to let mortgages tend to command a higher interest rate as they are deemed riskier than traditional residential mortgages as they rely on a property being rented out as a method to pay the mortgage costs.

What are the criteria for a buy to let?

As opposed to a regular homeowner mortgage, a buy to let mortgage is seen as having slightly more risk involved. This is due to additional potential problems occurring in a property that is being rented. Where income from a job in a homeowner mortgage is viewed as being generally more reliable.

This means you’ll need a half-decent credit score, proof of rental income and typically a 25% deposit for a buy to let.

Additional documents like proof of ID, proof of address and insights into your personal income will also be asked for most of the time.

A UK citizens driving licence

You may also need a minimum annual income. This is usually a figure of around £25,000. Having said this, some lenders don’t require a minimum income at all and some require more.

Also, deposits usually differ from the type of home you are buying as it has to be relative to the value of the property. An ordinary figure for this is around 25% of the value of the house. For example, for a house valued at £600,000, you will have to produce a deposit of £150,000

Who can get a buy to let mortgage?

Some lenders will also ensure you already have a mortgage and the mortgage you’re taking out isn’t for your first property. Speaking to a mortgage advisor may be helpful. 

Rental income is used as part of the bank’s assessment of how much they will lend. Rental income usually has to exceed interest payments by 125% – 145%.

Typical Mortgage contract types include deals where the interest rate is variable (up to the lender), tracker (change in line with The Bank of England’s base rate) or fixed (Where interest is fixed for a set period of time). 

Buy to lets are usually available to those who have experience as homeowners, it is possible as a first-time buyer first time landlord to get a buy to let mortgage but will require a specialist lender

Are there age requirements for owning a buy to let property?

Exemptions include those under the age of 18 and sometimes over the age of 75. But this still depends on your lender.

Is a buy to let mortgage based on income?

A bigger factor for a lender is the rental income of your property instead of your personal one.

However, sometimes mortgage advisers and lenders also consider if your income can support your lifestyle.

In these cases, submitting your living expenses and income by sending bank statements would be a great way to get approved for a mortgage with a lower income.

Is there a minimum income for buy to let?

Usually, this amount is around £25,000 per year, but this figure can be more or less dependent on which lender you approach.

How does a buy to let mortgage work?

The lender will consider multiple factors in relation to the property you are buying such as personal income, the deposit you are willing to put down, credit score, living expenses and the rental income from the property.

From there, they will approve or disapprove your mortgage application. 

Unlike most mortgages, with a buy to let, it is typical to only have to pay back the interest on the mortgage every month. Usually, this is around 2 – 6%, depending on your mortgage agreement. On the other hand, the deposit for a buy to let mortgage is more than a typical residential mortgage at 20 – 40%.

Woman paying a deposit online for buy to let

In comparison, a “help to buy” residential mortgage requires just a 5% deposit. Those are used to buy a house to live in 

Buy to let mortgage as opposed to a residential mortgage is the amount you can borrow depending on the potential rental income from a property rather than your personal income. 

Buy to let mortgage case study

Following these numbers, here’s a typical buy-to-let mortgage case study:

If you had a £100,000 house, you could buy it using a 5-year fixed-rate 2% buy-to-let mortgage with a £25,000 down payment, receive £75,000 and have to pay back £1,500 per year. (2% of £75,000)

If the rent for this property was £800, you could make up to 30% profit on your money over the 5 years.

However, this figure for profit is usually a lot lower because interest payments can get a lot larger and creep up to 3% – 6%. Furthermore, there are often additional costs for the landlord on top of mortgage repayments such as mortgage arrangement fees, house purchase insurance, professional fees and costs, stamp duty and land tax and taxable profit on your rent. You may also need to pay land and buildings transaction tax if you are buying a property in Scotland.

Do you own the house after a buy-to-let mortgage?

A lot of buy to let mortgages are interest-only. This means you just pay the interest on the property loan rather than paying back the full amount of equity. At the end of the mortgage when you have paid back all interest, you will have to pay off the equity in the loan. This is usually done all at once by selling the property.

As a result, doing an interest-only mortgage won’t allow you to own the property outright.

However, there are some ways around this.

Remortgaging your property

You can move the mortgage from one lender to another or from one deal to another– this is called remortgaging. This is typically done to refinance the mortgage to another lender where the rate of interest is lower.

If your property had gone up in value, you can take some money out of the value of the house and perhaps use it as a deposit for a new buy to let property. 

This is one of the ways in which you can buy a property with no money by pulling out the equity you didn’t otherwise have access to.

Use a capital repayment mortgage instead

If you are a landlord who likes the idea of owning your property, the most straightforward way of doing this would be to buy a buy to let capital repayment mortgage.

How this works is instead of only paying back the interest on the mortgage loan you have taken out to buy your buy to let, instead you pay back everything. The capital of the loan and the interest.

As a result, you will end up paying more than if you just took out an interest only mortgage and you will end up with less profit but it is with the added benefit of owning a property without ever having lived in it.

This strategy will work well if you are relying on the appreciation of the property over time as you will be able to sell the property for profit as you now own it.

How much deposit do you need for a buy to let?

Buy to let mortgages are associated with higher risk as the rental income is less predictable. Therefore a higher deposit is required. As a result, they usually require a 20% – 40% deposit and insurance products like rent guarantee insurance can be used to offset this risk if you are an inexperienced landlord.

Given that the average price of a house is around £300,000, an average deposit would be in the region of £60,0000 – £120,000. This form of mortgage is therefore quite capital-intensive.

Is buying to let still worth it in 2022?

If you are interested in a property as an investment and the numbers in the deal work to deliver a good return then buy to lets are definitely a worthy route to look down when it comes to investing.

So, despite a bleak economic climate, buy to lets will always work given the numbers make sense. A higher interest rate on mortgages due to the government trying to combat inflation means it’s harder to find a suitable property where you can price the rents in a suitable way for the rental yield to be about 130% of the mortgage repayments.

This percentage figure is what most landlords look for when taking out a buy to let mortgage because mortgage advisors will not approve a mortgage without proof the rent is sufficient to pay it off.

If this is a problem for you as a landlord, consider going for a longer-term buy to let mortgage because lenders tend to relax this 130% figure the longer your mortgage goes on.

You could also use your personal income to increase the rental income on the property by adding value to the deal. This could take the form of a new kitchen or bedroom on the property.

Large home on top of a hill

Once complete, you may then qualify for the same mortgage after increasing the rental income and therefore the value of the property. This has the added benefit of making sure there is profit to be extracted from the property to pay off the mortgage once the mortgage is over too. This is known as top slicing in the property industry.

Can you remortgage on a buy to let mortgage?

Yes. In fact, after a fixed term interest only mortgage, it is usually recommended to remortgage your buy to let mortgage if you cannot pay it off. It shouldn’t even matter if you currently have a tenant in situ as this process is done only on behalf of the landlord.

This is because after a fixed-rate interest deal, which usually lasts between 3 – 5 years, you may have to pay 2 – 4% extra interest per month after this fixed-rate period is over. And your lender may move you to a variable-interest mortgage. 

To get around this, most landlords end up paying off the mortgage by selling the property. However, you can also remortgage to avoid this interest and continue to use rental income to pay it off over 10+ years.

How do you remortgage a buy to let mortgage?

First, you can start by inviting a surveyor or appraiser over to your property to get a new valuation for the property. You should start this process around 6 months before the end of the deal of your current buy to let mortgage.

Your mortgage adviser will help you to collect the correct documents needed and conduct a fact find. They will then research the market for the most suitable mortgage deal available based on your situation. 

They will then apply to the mortgage lender; help organise the valuation and work with your conveyancers, including the underwriters from the lender to get you an offer and eventually completing on it

You may need to renew other things at the same time as your mortgage expires like building insurance.

How soon can you remortgage a buy to let?

If you are locked in on a deal you should look to start reviewing your options 6 months before the end of the deal. The closer you can get to this date, generally, the longer you wait the better the deal on a new mortgage is available to you. This is because the property is proven to produce consistent rental income and the property may also be starting to appreciate in value. 

As you wait, you also get to take advantage of inflation by paying back the debt you owe over a longer time period and into a future where the money you owe now is worth less in the future in terms of value.

If you have to remortgage sooner, there is sometimes a minimum of 6 months in which you can remortgage your property but some lenders have no minimum time. If you decide to do this you may also have to pay an early repayment fee.

Despite any fees, it may still save you money to remortgage your property so speaking to a mortgage advisor or doing some comprehensive comparison and research would be your best bet.

Can you remortgage to buy a rental property?

It is extremely important to research in detail and calculate how much money you will actually save before you apply for a new mortgage. Costs like early repayment fees and arrangement fees may offset any savings you make from remortgaging your buy to let in the first place.

Additionally, making sure you have enough spare income to cover your original landlord costs like landlord boiler cover for example should also be used in your calculations as you will still be responsible for the property

Which taxes do I have to pay on a buy to let mortgage?

There are a few different types of tax you have to pay at various stages in your property journey of taking out a buy to let mortgage. Some of these taxes have been changed over the years so it is important to stay on top of things by checking out the legal advice on the government website which you can find here.

Calculating mortgage repayments using a calculator

Capital Gains Tax

Capital gains tax is paid on any profits made from selling a property given your profits exceed £12,300. For example, if you bought your buy to let property at £100,000 and sold it three years later for £112,300, you will end up paying no capital gains tax if this is the only property you are selling in the tax year.

However, if you do fall into the tax bracket, the amount of tax you pay will depend on if you’re a basic rate tax paper or higher rate taxpayer. Higher rates are paid at 28% per year and lower rates at 18%.

To calculate your capital gains tax as a lower-income taxpayer on a buy to let mortgage, you’ll need to:

  • Find your taxable income by using this link
  • Calculate your taxable gains by clicking here
  • Deduct £12,300 from this figure (unless you are a trust, find out here)
  • Add this value to your taxable income
  • Find 18% of this figure

Income Tax

Like capital gains tax, there are basic rate taxpayers and higher rate taxpayers and additional rate taxpayers when it comes to income tax. They all pay taxes at different rates.

The thresholds for meeting this as of 2022 are as follows:

2022 income tax rates UK thresholds

Each band of taxpayers (excluding those earning £125,140 and over) can deduct £12,570 from their income and calculate the percentage of taxes owed on the remaining figure. This is because there is an allotted personal income which isn’t able to be taxed

Mortgage Interest Tax Relief

In 2022, deducting your mortgage payments from your personal income is no longer allowed. This change was taken into effect in April 2020.

So, unfortunately, if you are a landlord you will be taxed on your rental revenue rather than the net profit of the rent you collect once you have deducted mortgage payments.

As a result, the good news is, landlords in a lower-rate tax bracket are eligible to receive something called tax relief credits. This is paid at 20% of your mortgage interest.

For example, if your interest-only mortgage payments on your buy to let property are £10,000 for the year, you will receive an additional £2,000 to help offset the additional business expense from the government disallowing you to deduct mortgage payments from your personal income.

For higher-rate taxpayers, you regrettably won’t qualify for this interest tax relief.

Stamp duty

Whenever a landlord buys a property, in 2022, you will have to pay stamp duty on a buy to let which is calculated as a percentage of the property value.

Depending on the property price, this is in the range of 3% to 15%. Click here to find the relevant stamp duty tax bands. They increase as your property price goes up in value.

These stamp duty tax bands are the same as when you buy a second home. More can be found on how to buy a second home on the Lofti website.

Conclusion

There are a lot of terms to familiarise yourself with when it comes to buy to let properties. What’s more notable is the range of variables there are when it comes to your mortgage.

If you are still unclear, seek professional advice from a solicitor or mortgage advisor and be prepared to assign enough time to research till you’re comfortable making a decision.

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