Buy to Let Mortgages

What is a buy to let mortgage?

A buy to let mortgage is simply a mortgage especially for a buy to let property. If you plan on renting out your property you must have a buy to let mortgage. It’s similar to an ordinary mortgage in that you borrow a large sum of money for a set period of time, but, because you won’t be living in the property, there are some important differences.

How buy to let mortgages work

The first difference is that the vast majority of buy to let mortgages are interest only – so your monthly payments will only pay off the interest on the loan and you don’t pay off the full sum (the capital) right away. This means that the monthly payments will be less, but you must be prepared to either pay off the loan in full, sell the house or remortgage at the end of the mortgage term. This means that you can buy the house and make money on the rent for the payment term (for example, 25 years) and then pay off the mortgage by selling the house at the end.

Repayment mortgages (where the capital and the interest are paid back in monthly instalments) are uncommon for buy to let properties. You’d have to charge more rent to cover the increased monthly price. However, that means that at the end of the mortgage term you could either carry on letting it out and keep all of the rent yourself, or sell the house and keep the money, instead of having to use it to pay off a mortgage.

Another key difference between a residential and buy to let mortgage is that the amount you can apply for depends on the rent you’re planning on charging – not your salary. So if the property is large or ideally located, you’ll be able to charge more rent and so can get a larger mortgage.

The third difference is the deposit. Buy to let mortgages are considered much riskier than residential ones so lenders will often require a larger deposit, often at least 25%. Just like ordinary mortgages, the bigger the deposit the better the deal you’ll be offered, so you should put down as big a deposit as you can.

Lending restrictions

The Bank of England has recently started to impose tougher lending restrictions with strict affordability tests. Part of this includes using Interest Cover Ratios (ICRs). An ICR is the ratio to which a property’s rental income must cover the mortgage payments made by the landlord. Lenders can use this ratio to work out how much money the landlord is likely to make.

Many lenders want the predicted rental income to be 125% of the landlord’s mortgage payments. So, for example, if the landlord will receive a rental income of £750 per month, an ideal mortgage repayment amount would be £600 per month.

However, some lenders may want a higher ICR – sometimes as high as 145%.

Before any agreement is signed the lender will need to be confident that you’ll actually be able to get the rental income you’ve predicted. They often do this by looking at the price of similar properties in the area.

Mortgages for portfolio landlords

Portfolio landlords are landlords with four or more properties.

If you’re a portfolio landlord it’s a little more difficult for you to access additional finance. While you used to just be required to provide overall profit and loss figures when applying for a mortgage or remortgage, now you must show mortgage details, cash flow projections and business models for every property you own. If you have lots of mortgages in this portfolio, it will be harder to get another one.

There are a number of conditions that your lender might ask for:

• There may be a maximum number of properties you’re allowed in your portfolio.
• They may ask for a maximum Loan-To-Value ratio. The Loan-To-Value (LTV) ratio is the ratio of the loan to the value of the asset (the property in this case). So lenders may ask for an LTV of 65% or lower across your portfolio.
• They might insist on every property in your portfolio having an ICR of at least 100%.

Some banks and lenders have adopted a system known as ‘top slicing’. This is when the landlord’s personal income (such as a pension or salary) is taken away from their portfolio and is included in affordability assessments. This means that if your personal income is significant you could use it to bridge any shortfalls.

Remortgaging

Sometimes refinancing can be a better option than buying more property, especially given the Stamp Duty surcharge for property investors and cuts to mortgage interest tax relief.

There’s an increase in the number of lenders cutting up-front fees – according to Which? one in five remortgaging products are being offered on a no-fee basis. Cashback incentives are also on the rise.

Buy to let mortgages for first time buyers

Buying a property to let is a great option for first time buyers who live somewhere with high house prices, such as London. Buying a property to let out in a cheaper area can be a great additional income to go towards saving for a deposit.

However you will inevitably face some challenges. There will likely be fewer options available to you so you’ll need a bigger deposit and you won’t qualify for the Stamp Duty relief that most first-time buyers would. You will avoid the 3% surcharge that usually applies to buy to let buyers, but you’ll have to pay it if you buy a property for yourself or a second buy to let property without selling the first one beforehand. Also, remember that you can’t use Help To Buy for buy to let properties.