Thinking of borrowing money to purchase an investment property? Here are five things to know about buy-to-let mortgages.
Buy-to-let properties are often seen as an attractive option if you're wanting to make an investment. Rents have been rising steadily across the UK; and the trend seems set to continue.
But while it’s tempting to run to the bank for a buy-to-let mortgage so you can take part in the rental boom, it’s good to weigh your options first. Here are five things to think about before signing on the dotted line.
1. It’s harder to qualify for a buy-to-let mortgage
Most mortgage lenders consider buy-to-let mortgages to be riskier than residential ones. Statistically speaking, borrowers are likelier to default on a buy-to-let mortgage than they are on other types of mortgage. Because of this, the eligibility criteria are typically more stringent.
To begin with, most banks have minimum age requirements. You’ll usually have to be at least 25 years old to apply. There’s also a minimum income requirement. For most banks, this is £25,000 per year.
Buy-to-let mortgages also require a larger deposit. While it’s possible to borrow up to 95% of the purchase price when you take out a conventional residential mortgage, most buy-to-let mortgage lenders will insist on a deposit of at least 25%.
Finally, there’s a limit to how much you can borrow. Most banks will only allow a maximum of £2 million in buy-to-let mortgage debt. You also cannot have more than three to five (depending on the lender) buy-to-let mortgages running simultaneously, even if you’re one of the lucky few who can afford it.
2. The affordability calculation is worked out differently
As part of any mortgage application, your lender will carry out an affordability assessment. This is done in order to determine how much you can afford to borrow.
In residential mortgages, the affordability calculation is worked out on the basis of your personal income and expenses. Not so when you take out a buy-to-let mortgage
In buy-to-let mortgages, the affordability assessment is based on the property’s income potential. In other words, it’s not your personal circumstances that count, but whether the rental income you could earn from the property would be enough to cover the mortgage repayments.
In addition, buy-to-let mortgage lenders also oblige you to charge a minimum amount of rent, which ensures you have a buffer to cover vacancies in between tenancies. The minimum amount is usually your monthly mortgage repayment, plus 25%.
Let’s put it in context.
Let’s say your mortgage repayment is £500 per month. According to your mortgage’s terms and conditions, you must rent the property for your monthly repayment plus 25%. This means that the minimum amount you can rent your property for is £625 [ 500 + (25/100 x 500) ].
3. There’s more to a buy-to-let mortgage than just monthly repayments
According to a recent study, many landlords overestimate their profits by as much as 50%. This is mainly because they overlook some of the expenses involved in owning a buy-to-let property.
While your monthly mortgage repayments will be your biggest expense, there are also other costs. Some are one-offs, such as mortgage processing fees, legal fees, stamp duty and other costs associated with taking out the mortgage in the first place. However, as a landlord, you’ll also be responsible for a number of ongoing costs:
estate agency fees
cleaning, repairs and maintenance
buildings and landlord insurance
4. You may be liable to pay tax on your rental income
Rent from your buy-to-let property qualifies as income, which means you’ll need to declare any profit you make from your rental property on your tax return and pay income tax. How much tax you’ll have to pay will depend on which tax band you fall in.
Up to £11,500 - 0%
£11,500 - £45,000 - 20%
£45,000 - £150,000 - 40%
£150,000 and over - 45%
*If you live in England, Wales or N.Ireland. Tax bands if you live in Scotland vary slightly
You can determine your tax liability by deducting allowable expenses from your total rental income. Allowable expenses include:
− the interest on your buy-to-let mortgage
− estate agency fees
− council tax
− maintenance and repairs (provided you keep all receipts)
− utility bills
− any marketing expenses
5. You CAN rent to family and friends, but forget about discounts or freebies.
One of the most common misconceptions about buy-to-let mortgages is that your lender won’t allow you to rent the property out to relatives or friends. This is untrue. You can rent out a buy-to-let property to anyone. However you’ll need to make sure your tenants pay the correct amount of rent, irrespective of who they are.
Since your lender will require you to rent your property out for the equivalent of at least 125% of the interest on your mortgage, it’s impossible to give family or friends a discount (or to let them live in your property rent-free). You’ll also need to make sure you comply with all applicable laws and regulations.
As awkward as it might be, it’s best to get your relative or friend to sign a formal rental agreement. This ensures you’re both on the same page about your respective rights and responsibilities and avoids unnecessary arguments.