Mortgages Guide | Mortgage Help Product Information

TheMoveChannel.com | Buy To Let Mortgages

Introduction

The number of people buying property as an investment has ballooned over the last decade. But you can't just buy a property with a normal mortgage and start renting it out - letting your property is usually against the terms of your mortgage agreement. Lenders take a dim view of people who let out their property without permission and can even end up serving you notice on the property.

Buy to let is a joint initiative that was originally set up by ARLA and a small panel of mortgage lenders to help individuals invest in the residential property market without having to pay commercial rates of interest on their mortgage.

Whilst the comparative robustness of the residential property market is the main driving force behind the increase in the popularity of this type of investment, there is no doubt that the improvements to the buy to let mortgage products available on the market have also been an important factor.

There are now around 70 lenders offering range of deals that now include discounted, fixed, variable, tracker, flexible and even self certification mortgages, helping to make buy to let an investment that is accessible to a broader section of the population.

One of the key things to remember is that buy to let should not been seen as a short term option, but if you research, plan and manage your investment correctly, you should end up making a profit in the medium to long term. It is not without its risks and involves considerable initial and ongoing costs including lettings agent commission, management fees, tax, insurance, legal cover, maintenance and repairs, service charges, and ground rent.

Features of Buy To Let Mortgages

Up till the end of the nineties, buy to let mortgages offered rates of interest that were significantly higher than owner-occupier mortgages, often charging a premium of more than one percent.

Today's mortgage market contains a large number of special products that are aimed specifically at the buy-to-let market. These mortgages do not differ vastly from other mortgages - you can usually find discounted, fixed, capped and base rate tracker buy-to-let mortgage rates. Although you may still not get such heavy discounts and introductory offers as you would with owner-occupier mortgages, but at least the Standard Variable Rate is usually more or less comparable.

However, there are three key differences in comparison to standard mortgages:

  • The biggest single difference between a buy to let mortgage and homeowner mortgage is the maximum proportion of the property value that the lender will advance. Almost without exception, you will have to pay a larger deposit on a buy to let property. The minimum deposit is usually 15 percent, but some of the more competitive deals will only be open to those with larger deposits, often as large as 25 percent. Therefore, this type of investment is only viable if you have the necessary deposit as well as the funds to cover your mortgage payments during void periods, maintenance of the property and other miscellaneous costs, realistically putting it well out of the reach of many people.
  • Although the gap has narrowed, buy-to-let mortgage rates are not normally quite as competitive as homeowner mortgages. Since you are not paying back the mortgage directly to the lender and will probably be relying on your tenants to pay their rent, the lenders see buy-to-let mortgages as more risky than other types of home loans. This means that you have to pay a higher rate to compensate them for the higher level of risk.
  • Lenders will normally incorporate a proportion of the rental income when calculating how much money they are willing to lend you. Unlike the lending criteria for other mortgages, where the lender may stick fairly rigidly to the income multiples that they use, this allows you to purchase property beyond your normal price range - provided that you can raise the deposit. You should still be slightly wary of over-stretching yourself though - remember that you cannot guarantee you will always have tenants in the property, and if it is vacant, you will have to foot the mortgage bill on your own.
  • A secondary criteria is that most lenders set the amount by which they expect rental income to exceed your monthly repayments. This usually ranges from 125 percent to 140 percent and will normally be verified using some form of independent market valuation or letting appraisal. This is so to ensure that the rental income covers the mortgage and all of the other running costs such as agents fees, insurance, void periods and so on.

Two final points as regards the features of buy to let mortgages:

Watch out for hefty redemption penalties that exist on some buy to let mortgages - typically six months interest for the first 3 years.

Remember that when you sell the property, you are normally going to be liable for Capital Gains Tax at your highest rate of income tax, so you should arrange for a good accountant or specialist advisor in making sure you address this, and all of the other tax issues, as effectively as possible.

Buy To Let Capital Raising

Capital raising is a feature of many buy to let mortgages that enables investor landlords to draw down funds from the existing mortgage on a property, often to help finance further property investment. In times of rapidly rising prices, this can be an incredibly effective way to build a property investment portfolio, made possible by the repayment of debt and rising property prices.

Take the following example:

An investor buys a property for £130,000 with a mortgage of £90,000. Some time later, the value of the property has risen to £150,000, while the outstanding mortgage debt has been reduced to £70,000. This means that the investor has £80,000 worth of equity in the property.

The lender has set a maximum loan-to-value of 80%, which equates to £120,000 on a property worth £150,000. This means that there is still £50,000 worth of equity that the landlord can free up and still be within the loan to value requirements of the lender.

With the lender's permission, this could then be used as a sizeable deposit on another new property, along with a slush fund for refurbishment, marketing and maintenance costs.

The money that is drawn down doesn't have to be used to expand, as this is not the aim of every investor landlord. It could be used for repairs to the property against which the mortgage is secured, used to reduce the loan size on another property with a less favourable mortgage rate or some other purpose that falls within the definition of acceptable use by the lender.

Flexible Buy To Let Mortgages

Flexible mortgages have begun to pop up in the market for non-conforming mortgages. Buy to let investor landlords are one group of borrowers that are ideally positioned to benefit from the flexible features that some mortgages offer.

Flexible buy to let mortgages are a very recent arrival in UK, but it is becoming more and more common for buy to let mortgages to offer certain flexible features such as daily interest, overpayment and lump sum payments.

If, as it should do for most of the year, the rental income exceeds the costs of running the property and servicing the mortgage debt, then the surplus can be ploughed back into the loan instead of being kept in a separate savings account.

This then allows the investor to either gain full ownership of the property more quickly by paying off the loan early, or else release the equity at an earlier stage in order to grow their property portfolio.

A couple of other features of flexible mortgages can be very useful for the buy to let investor:

  • If rent is collected in weekly or fortnightly instalments, then a flexible mortgage that allows payments to be made to match the frequency allows the borrower to pay off the capital more quickly, as they do not have to wait until a full month's worth of rent is collected.
  • Given that void periods generally affect most properties at some point each year, a mortgage that allows the borrower to take a payment holiday can be useful in helping to get through periods when a rental property is unoccupied.