Investing in a property to rent out may seem attractive for potential income and future savings. However, it’s vital to recognize the substantial risks involved. Acquiring a buy-to-let mortgage is a key component when purchasing a property for rental purposes. This type of mortgage, while sharing similarities with standard residential mortgages, has fundamental differences. Understanding these distinctions is essential, and this guide aims to provide comprehensive information about buy-to-let mortgages, aiding you in determining whether this investment aligns with your financial objectives.
Similar to standard residential mortgages, buy-to-let mortgages have specific nuances that potential landlords must grasp. This guide aims to elucidate these differences, offering valuable insights into the intricacies of buy-to-let mortgages. Whether you’re a novice investor or have previous experience, understanding these aspects is crucial for making informed decisions and navigating the complexities of the property investment landscape.
What is different about a buy-to-let mortgage?
If you’re considering renting out your home, securing a buy-to-let mortgage is imperative. Unlike standard residential mortgages, which are designed for owner-occupiers, buy-to-let mortgages entail higher risks, primarily due to potential challenges in rent collection and property occupancy. To mitigate this elevated risk, buy-to-let mortgages typically require a larger deposit, often starting at 25% of the property’s total value, with some lenders or mortgage types demanding deposits as high as 40%.
In addition to the substantial deposit, other fees associated with buy-to-let mortgages are generally higher, including arrangement fees that can reach up to 3.5% of the property’s value. Unlike residential mortgages, many buy-to-let mortgages adopt an interest-only structure, where landlords make monthly interest payments without reducing the principal loan amount. While this results in lower monthly payments, landlords must repay the entire mortgage at the term’s end, often by selling the property. It’s crucial to have sufficient savings to navigate potential challenges, especially if property values decline.
What should one consider when getting a buy to let mortgage?
The monthly interest payments for a buy-to-let mortgage are influenced by factors such as the initial loan size, property rental value, and individual financial status. However, the choice between a fixed rate or variable rate mortgage significantly impacts these payments. Each mortgage type comes with its own set of pros and cons.
Fixed Rate
Opting for a fixed-rate mortgage typically spans two to five years, ensuring consistent monthly interest payments throughout the term. This stability allows you to predict your monthly expenses, providing tenants with the assurance of unchanging rent. However, fixed rates tend to be slightly higher than variable rates, and you won’t enjoy any reductions if interest rates fall. After the fixed-rate term concludes, you’ll be moved to your provider’s standard variable rate, often one of the costlier options. It’s advisable to explore new deals before the term ends to avoid the potentially expensive standard variable rate.
Standard Variable Rate
Standard Variable Rate (SVR) mortgages are commonly the default option after your initial deals end. These tend to be among the pricier mortgage options, featuring higher interest rates. If you find yourself on an SVR, it’s wise to seek a more cost-effective deal. The SVR rate is subject to change at your lender’s discretion. An SVR’s notable advantage is the absence of exit fees, allowing you the freedom to switch to a better deal without incurring additional costs.
Letting Agent Fees
Utilizing a letting or estate agent for property management entails paying letting agent fees. Their services, ranging from credit checks to contract drafting, come with associated costs. Fees may also contribute to health and safety checks, vital for ensuring the property meets living standards. Ongoing management charges usually range from 10% to 17% of monthly rental income. If opting for a one-off letting service, the typical charge is approximately one month’s rent.
Landlord Insurance
Buy-to-let insurance, or landlord insurance, safeguards your property, its contents, and covers landlord liability. While buildings insurance is typically required by mortgage providers, offering protection against damage or fire, contents insurance, covering existing furniture, is optional. Tenants are responsible for insuring their possessions. Landlord liability, addressing injury or death of tenants or visitors, is generally not obligatory but may be required in specific UK regions, particularly when renting to students.
Income Tax
Income tax applies to the rental income received from tenants, with rates at 20%, 40%, or 45%, based on your tax band. Currently, you can lower your income tax by deducting allowable expenses, such as letting agent fees, council tax, and property maintenance, from your rental income. However, the government intends to phase out these tax reliefs by 2020.
Capital Gains Tax
Selling your buy-to-let property for a profit requires paying Capital Gains Tax (CGT). The rate, higher than for other assets, is either 18% or 28%, based on your tax bracket. If your profit exceeds £11,700, CGT applies, and with a partner, you can combine allowances, raising the threshold to £23,400. Declare the property sale profit on your Self Assessment tax return at the tax year’s end.
How big a loan can you get?
The amount you can borrow for a buy-to-let mortgage relies on your property’s potential rent, with lenders often requiring 125% to 145% of your monthly interest in rental income. To estimate rent, research similar properties in your area, but lenders may need a surveyor’s verification. For instance, if your interest payments are £600, you’d need to charge at least £750 monthly for a 125% requirement. Higher rent increases your loan eligibility.
Like all mortgages, buy-to-let mortgages have a loan-to-value ratio. If your property is valued at £200,000 with a £180,000 mortgage, your LTV is 90%, requiring a £20,000 deposit. This deposit represents the remainder after calculating the size of your loan as a proportion of the total property value.
Who can get a buy-to-let mortgage?
Applying for a buy-to-let mortgage differs from a standard residential mortgage and involves specific eligibility criteria. To qualify, you typically need to own a home, either outright or with an existing mortgage. Your financial situation is scrutinized, and a good credit rating, minimal debt, and an income of at least £25,000 per year enhance your chances of securing a favorable deal. Age can also be a factor, as many lenders set upper age limits, often around 70 or 75 years old, referring to your age at the mortgage term’s end. While some lenders have no upper age limits, others may require borrowers to be 45 years old or younger for a 25-year mortgage.
What happens at the end of the mortgage?
After the conclusion of your interest-only mortgage deal, you’re obligated to repay the property’s initial cost. Typically, landlords achieve this by selling the property, aiming to make a profit. However, the process isn’t always straightforward. If property values have declined since the purchase, resulting in a lower current value than the initial one, you may incur a loss. In such cases, you’ll need to cover the shortfall with your own funds.
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