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

Introduction

If you are familiar with how mortgages work, you would know that a mortgage is a loan that is taken out in order to buy a house with less equity than the value of the house. In order to benefit from this, what would be the deposit required to put down on a house?

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

To answer the question of how much of a deposit you’d need. The answer usually lies between 20% and 40%. However, it is not unheard of for a lender to charge up to 45% or as low as 15%. It depends on the property, the experience of the investor and how much rental income the property they are buying is able to earn.

The higher the deposit is, the lower the amount of money you would have to pay back so the lower the monthly repayments on the loan and the lower the loan’s interest. Having said this, if the interest rate is high and it is an interest only mortgage. Then you may still have mortgage payments that are quite high.

How to reduce the amount of deposit you need for a buy-to-let mortgage

Because the amount you can borrow is impacted by the rental income of the property, a good place to start would be to try and increase the amount of rental income you can get. This isn’t just as simple as charging more money for the rents and increasing them because if you put the rents higher than the market rates for the area then no one will rent the property and you will struggle to fill it.

You have to raise the value of rent by raising the value of the property along with it. This means adding value to the premises and making sure the tenants who will move into the property receive the extra benefit.

Examples included adding in a new kitchen, adding an extra bedroom to the property and hence being able to charge for an additional room if you are building a HMO or simply just making sure the property is well insulated with a good EPC rating so people of the property are willing to pay more for rent to reduce their utility bills like gas and electricity.

Another way in which you can reduce the deposit you’re able to pay for a property is to speak to more lenders and get advice from a range of experts. If one bank offers you a mortgage with a 40% deposit, another could offer you 35% for example. Every lender does their own credit check and makes a decision based on their own set of risks. 

The more you look around and the more you know all help in your search for a mortgage so don’t just settle with the first piece of mortgage advice you hear.

Finally, rather than increasing the rent of the property, you could also increase the deposit you are able to put down. Ideas like simply saving for a bit longer, taking equity out of homes you already own or partnering with an investor to pool your money in a deposit could be ways to meet the requirements for a property. Especially if you know the property is a good deal and it isn’t worth missing out on.

What is the loan to value (LTV) ratio?

The loans to value ratio is another way of describing the percentage of the deposit required yet they do not directly mean the same thing. This is because the loan refers to the mortgage of the property and the value refers to the deposit that is necessary to be put into the property.

For example, someone could say that a deposit is needed of 20% of the value of the house but someone else can say that the Loan To Value (LTV) is 80%. Both of these would be correct.

How to calculate how much you can borrow in a buy-to-let mortgage

In order to calculate how much you can borrow in a buy-to-let mortgage you will also need to take into consideration the amount of tax you will owe at the end of the tax year. Lenders will typically have a more stringent stress test for those who pay more tax because if you have more tax to pay, it is more likely you won’t be able to afford the mortgage payments.

As a result, lenders ask for the rental income from a property to bring more than 125% of the mortgage repayments for those who are higher rate taxpayers, additional rate taxpayers and are taking out a HMO mortgage. This percentage is referred to as the ICR of a property (Interest Coverage Ratio).

HMO mortgages are considered commercial loans and commercial lending aren’t as safe. This is because there are more expenses for this type of investment so a landlord has to pay more in expenses before they are able to pay back the mortgage.

This is why HMO mortgages also have a higher ICR than most. Nonetheless, HMO’s usually have a higher rental yield anyway as the rental income is based on the rent collected from all the bedrooms in the property and each bedroom is rented separately. In a conventional buy-to-let, there is just one tenant with one tenancy agreement.

The table below shows what the typical rental income would be for a £200,000 loan based on what tax band you are in and then based on if you were investing in a HMO. This goes to show you will need to produce a lot more rental income for a higher rate taxpayer to pay back the mortgage repayments (£917 based on a 5.5% interest rate).

How to get a mortgage in principle for a buy-to-let mortgage?

A mortgage in principle or AiP (Agreement in principle) can be gained from a lender through their website or by calling them up. It is essentially a professional document that gives an indication of how much money you will likely be approved for if you were to take out a mortgage based on the information you provided.

First, you will need to have a few bits of information to hand like the income you earn, personal details like date of birth and address as well as the rental income you expect from a property most importantly.

If you are able to prove this is true through a surveyor’s report which will give a detailed breakdown of what the rent should look like, this AiP will become a full mortgage offer if you decide it should be.

Once you have your AiP, you are in a better position to make offers for the property and you may be taken more seriously by those looking to sell a home. However, it is important you know about the details to do with an agreement in principle because if you have too many hard credit checks on a credit report in a short period of time like a lot of lenders do this can ruin your credit score.

What are the ways in which you can prove you have a deposit?

If having a deposit is one of the main ways you can gain approval for a buy-to-let mortgage. What are the ways to raise the deposit to prove to the lender you have the fund necessary? 

Pull out equity from another property

If you have other properties in your portfolio, this is a big advantage as you will have more equity you can pull out of a home in a remortgage. Or, you also have the option to sell the property and remortgage.

Take out a bridging loan

One of the first things you can do is take out a bridging loan which is a loan from a loan lender that is there to be paid back in a short period of time to a mortgage. Typically, this is used when you are planning to remortgage the property after you have spent the money from the bridging loan on renovations for the property. 

This will leave you with a remortgaged property you can let out for a higher rent than before and potentially some equity you are able to pull out of the house after you have paid off the bridging finance.

Use builder incentives

Sometimes, especially for builders who are larger developers, there are certain incentives for them to do work on your property or even build it from scratch. For example, some developers will pay your deposit on your mortgage or offer to pay the stamp duty of your property if you ask them to do renovations. This is more common when purchasing new builds.

Use a gifted deposit

Gifted deposits may be paid by a close friend or family member in order to help you meet the required deposit amount to buy a house. Typically this is more common for those buying their first home so it is rare that this happens for buy-to-let mortgages which are there for a landlord to make a property investment.

However, it can still be useful. A deposit can be gifted in full or it can be partly paid and only be a contribution. There are also legitimate ways to do this through a bank so there are no red flags as large amounts of money are moved around between bank accounts. For a guide on how this works click here.

Use a concessionary purchase

A concessionary purchase is used to describe a property that is sold for less than its market value. Simply put, the lower the value of a home, the lower the deposit used to purchase it. However, if the house is worth more than what it was sold for in the view of the lender, the lender is more likely to approve the mortgage.

Who can take out a buy-to-let mortgage?

Anyone can take out a buy-to-let mortgage if they pass the right mortgage check and they have a deposit that is enough for the size of the loan.

However, there are a few age restrictions. Some lenders will have a maximum age you can take out a deposit at 75 years old whereas others have the rule that a buyer should be 21 years old minimum. This varies on the lender though so you should check first before making any assumptions.

All in all, Mortgage companies primarily are concerned with whether they will get the money back that they have invested in a property through the loan. This includes making sure the asset is in good condition and will produce the right rent to make sure the mortgage repayments are able to be paid back.

Buy to let mortgage deposits explained with an example

In order to work out how deposits work in a buy-to-let mortgage. You can use a couple of different examples to show how lenders will process a deposit and why that is. In this case, an interest only mortgage is used to demonstrate.

Most of the time, lenders will approve a mortgage if the minimum monthly return of rent is greater than the value of the mortgage by 125% and the buyer is able to produce a deposit of at least 25%.

For example, a house is on sale for £100,000. The lender asks for a 15% deposit which is £15,000. This means the loan to value is 85% and the amount of debt on the mortgage is £85,000. A property like this may produce an income of around £4,000 per year and a rental yield therefore of 4%.

These numbers in real life would be slightly more compliant as things like stamp duty, potential repairs costs and fees would all come into effect. Also, it would be unlikely you would get a round number like this. It is common for the purchase price of a property to not be rounded and loan to value ratios to be difficult numbers like 73% for example.

Because of this, it is recommended to speak to a solicitor or mortgage advisor if any of these terms don’t make sense or the maths are hard to comprehend.

What is a stress test?

A stress test for a mortgage refers to the test a lender will do against the rental income of a property. For most lower rate taxpayers this rate is 125%. So the rental income from a property has to exceed the value of the mortgage payment every month by 125%.

However, for higher rate taxpayers and those taking out a mortgage on a HMO, this figure is more. Each leader will do this differently though and there are no hard and fast rules.

How much can you borrow with a buy-to-let mortgage?

How much you can borrow in a buy-to-let mortgage is not solely dependent on the deposit you are able to produce but is also dependent on the predicted rental income of the property. 

These two factors will be used in determining the offer you get from a lender that is to do with your mortgage.

How do buy-to-let mortgages work?

Buy to let mortgages are different to traditional residential mortgages in the sense that you only have to pay them back using the interest from a mortgage and the amount you can borrow is based on rental income from the property rather than personal income. 

There are also buy-to-let mortgages where you pay back the full value of the loan and at the end of the mortgage term you own the entire property but these are less common.

Overall, they work because landlords want to use buy-to-let mortgages to own a property and they want to do it without having to have all the value of the property up front. They are therefore prepared to pay more for the property over time in order to benefit from the rental income the property produces straight away.

Should you find a mortgage advisor for a buy-to-let mortgage?

It isn’t always necessary to find a buy-to-let mortgage advisor when finding a mortgage. You could just ask the lender or bank straight away who will put you through their mortgage application process.

Having said this, it is advised to speak to an advisor, especially if you’re new to investing. This is because when you apply for a mortgage the lender will likely put you through a hard check and if you have too many of those in a short period of time this can ruin your credit score.

As a result, you’d want to be confident you will gain approval for the mortgage by speaking to an advisor, taking out a mortgage in principle or a combination of both.

Where can you take out a buy-to-let mortgage?

Buy to let mortgages can be taken out from a range of lenders and banks. Some are local and some are more nationwide like Barclays bank for example seen here.

Lofti

Lofti has an in house mortgage advice available. This process walks you through the process of setting up a mortgage step by step. The Lofti team will apply to a mortgage lender on your behalf and make the process simple whether that be for a first-time buyer or someone who has multiple properties.

On top of this, with the Lofti software, you will have all of your property documents recorded in one place, no matter how many properties you have. If this isn’t enough, the software tracks your property portfolio so you are able to track how it performs in relation to the rest of the market. This gives you insights on the best time to remortgage, sell or increase the rents on the properties you have.

Use price comparison websites

Before you apply for a mortgage or even a mortgage in principle, looking at price comparison websites can be the best way to find a holistic view of the lender market quickly and easily.

The most popular price comparison website is Moneysavingexpert you can find the website for here. But there are others like CompareTheMarket, Which and even Moneyfacts.

What taxes do you have to pay with a buy-to-let property?

There are a few taxes that are paid with the purchase of a buy-to-let property. First of all, stamp duty has to be paid by the buyer of the property straight away. Also, Capital gains tax has to be paid on the sale of a property by the seller.

Throughout the duration of paying off the mortgage, a buyer will also pay income tax on the rent collected from a property but this can be offset from the rules around section 24 where buyers can receive tax relief credits.

To conclude?

Overall, to answer the question of how much of a deposit you need for a buy-to-let mortgage, the answer remains 20% – 40%. Throughout the article, reasons have been given for why this figure differs so much with the biggest factors being the economic and the rental income a property is able to produce.

All in all, anyone buying a house with buy-to-let mortgage may think that a lower deposit is better because you can borrow more. However, generally, this results in the owner having to pay more interest on the mortgage as they pay it back. So, the right deposit for one person may be different due to everyone having a different tolerance for risk.