Real estate is one of the most popular investments in the UK, and with good reason; not only is property in the UK generally increasing in value year after year, but the rental income from property can also offset the costs of paying a mortgage. With the right mortgage deal, it’s possible to build up equity in a property without contributing any more of your own hard-earned money, a highly appealing proposition for savers and investors alike. Buy-to-let (BTL) property can also be a great option for expats, as it allows them to generate income from UK real estate whilst living abroad.
The viability of buy-to-let property depends to a large extent on the deal you can arrange with your mortgage lender. There are many different criteria to satisfy, and BTL mortgages differ significantly from residential mortgages. In this guide we’ll talk about the difference between residential and BTL mortgages in the UK, and highlight some of the key areas borrowers must pay attention to when arranging a mortgage for buy-to-let property. Before committing to any mortgage, borrowers must make sure they talk to a qualified financial advisor to ensure that their deal is right for them.
Why invest in Buy-to-Let property?
Buy-to-let homes can be a great investment for a variety of reasons. Generally speaking, there are two main ways to make a profit from your rental property.
- Rental income: The money you make from renting out the home can make you a tidy profit and/or build up equity in the property.
- Increased value: If the value of the property increases, you stand to make a profit by selling off your stake in it.
The combination of increasing house prices and rental income allows BTL landlords to profit from the rental income alone, to build up equity over the course of a mortgage then sell, or to secure a property which they can move into later in life.
What constitutes a Buy-to-Let property?
A buy-to-let property is a home that is bought with the intention of letting it out to private tenants, as opposed to becoming the main residence of the mortgage holder. BTL property can be of any size and shape, from flats to whole homes, and come in various different types; a large house might be let out to a dozen different tenants, while a studio flat might only have a single lodger. Either way, if the property will be occupied by rent-paying tenants then the owner must take out a buy-to-let mortgage rather than a residential one.
Even if you’re not a professional landlord, you still won’t be able to take out a residential mortgage - letting on a casual basis, even to a relative, still requires that the property be financed through a buy-to-let mortgage rather than a residential one.
Buy-to-Let vs. Residential Mortgages
So why is this distinction necessary - surely a mortgage is a mortgage? Well, it comes down to the different sort of people who are likely to take out each type of mortgage. While residential mortgages for owner-occupiers will be taken out by anyone who buys a house to live in, buy-to-let mortgages are only bought as part of a business (even a casual letting arrangement counts as a business, since money is changing hands in exchange for services). In the eyes of the UK Government it’s important to closely supervise the residential mortgage market, because borrowers in this sector are less experienced and may agree to mortgages they cannot afford - recklessly approving mortgages was a key contributing factor to the 2008 financial crisis, which current regulation seeks to avoid.
On the other hand, the commercial buy-to-let market is left more to its own devices - borrowers here are expected to know the risks and responsibilities of taking out a loan, so regulation of the buy-to-let market is consequently less extensive. This doesn’t mean it’s easier to get a BTL mortgage, though - it just means that lenders are able to set their terms with a lot more freedom. However, recent changes to legislation are beginning to put the pressure on BTL lenders to apply stricter criteria in their lending (we’ll discuss this in more detail later).
While a residential mortgage may only be provided by lenders who hold a Financial Conduct Authority (FCA) license, buy-to-let lenders are not subject to this requirement. This means that many lenders will offer BTL mortgages but not residential mortgages, and there is consequently a significantly larger number of providers for buy-to-let mortgages.
“Accidental” Landlords?
There is another subtle distinction within the buy-to-let mortgage market, which accounts for the grey area between professional landlords and those who have become “accidental” landlords. As mentioned previously, landlord borrowers are assumed to have the experience and expertise necessary to take out a commercial mortgage; they know the risks, and won’t enter into an agreement they can’t afford. However, some individuals end up in letting a property unintentionally, often through inheritance, which leaves them ill-equipped to negotiate the sometimes-choppy waters of buy-to-let mortgages.
If a borrower can prove they are an accidental landlord, they will have to take out a “consumer buy-to-let mortgage”, or a CBTL. These mortgages are subject to regulation, and may only be obtained through an accredited lender; while the products on offer may not change, a borrower will only be able to turn to lenders who are licensed by the FCA. This gives them a greater degree of protection, but also prevents them from turning to many alternative mortgage providers.
Key Differences of a Buy-to-Let Mortgage
BTL mortgages differ from residential mortgages in many key areas. We’ll cover the most important of these here, from the costs of a mortgage to the qualifying factors that lenders will look at.
Deposit Size
If you’re looking for a buy-to-let mortgage you’re going to need a much larger deposit than you would for a residential mortgage. While many owner-occupied properties can be bought with just a 5% deposit, it’s rare to find BTL mortgages available with less than a 15% deposit, and more commonly with a minimum LTV of 75%. This reflects the fact that most lenders regard business loans as a less stable investment than a residential loan, and seek to offset this perceived risk by requiring a larger deposit.
Interest Rates
Interest on a BTL mortgage is almost always higher than for a residential mortgage, for the same reason that a larger deposit is required; the bank is taking on a riskier investment, and wants to profit accordingly. As a buy-to-let investor you’ll find that your deposit doesn’t get you as good an interest rate as it would on an owner-occupied property, so don’t expect to get anything like the deal you have on your own home’s mortgage.
Rent Coverage
Banks will want to know that the property will generate enough income to cover the costs of the mortgage; if the borrower can’t expect to make enough income from renting out the property, they’re likely to fall behind on their mortgage payments. Most lenders stipulate that the property must generate at least 125% of the annual mortgage repayment costs each year (the excess covers against void periods when the property stands empty). Many lenders want to see even stronger figures and will require evidence that the property will make 145% of its costs in a year, with large houses in multiple occupation (HMOs) requiring 170%.
Recently the UK Government has revealed its intention to make 145% the standard rental coverage ratio, which restricts BTL purchases to those who invest a lot of money in their property. In order to generate such a large profit it’s necessary for buyers to keep mortgage costs as low as possible, which is primarily achieved through a large deposit - this means that private BTL buyers will need to either put more money into their purchases or find cheaper property. It also restricts professional landlords’ ability to quickly expand their portfolio, because they’ll need to keep more money tied up in each property.
Minimum Income
To further guarantee that borrowers can meet their repayments, many BTL lenders also require customers to have an income of £25,000 in addition to their projected profits from the property they’re buying. This guarantees that the landlord won’t be forced to rely on income from this property in order to meet ongoing expenses, reducing the likelihood that they’ll fail to repay their mortgage because the money had to be used for something else. This requirement is typically a part of BTL mortgage applications for first-time landlords who already have a career - the bank wants to know that even if they mismanage their property, they’ll still be able to meet mortgage payments.
Tax Relief on a Buy-to-Let Mortgage
As a business, most landlords will be liable for taxation on any profits they make from their property. However, they’re also entitled to obtain tax relief on the costs of doing business; in the case of buy-to-let real estate, the outstanding cost is mortgage payments, and landlords are entitled to count the interest they pay on their mortgage (not the mortgage itself) as a business expense. In many cases a landlord’s main expense is the interest on their mortgage, so the ability to offset this cost against the tax they pay is incredibly valuable.
However, recent changes to the law regarding tax relief for landlords will reduce the amount of protection for landlords - instead of being able to offset their entire interest cost against their taxable income, they are entitled to only a 20% credit instead. For example, a landlord who paid £9,000 in interest over a year and made £10,000 from renting out a home would currently only be taxed on the £1,000 difference - at the basic 20% tax rate, this would give them a £200 tax bill, while a higher-rate taxpayer at 40% would pay £400 .
However, under the new rules, they’ll be charged tax on their entire income, from which they can then deduct 20% of the interest on their mortgage. A higher-rate taxpayer would have an initial bill of £4,000, from which they could deduct £1,800, while the lower-rate taxpayer would see their payments stay the same (a £2,000 bill minus £1,800). This rule therefore significantly increases the costs of letting out a property if you’re in a higher tax band, while leaving those in the basic rate of tax unaffected. In order to make any profit at all as a higher-earning taxpayer you’ll have to keep your mortgage interest costs to a maximum of 75% of your rental income.
This rule is part of the Government’s decision to try and slow down the buy-to-let property market by making it a less attractive investment for high earners. The idea is to reduce the number of properties being bought up by middle-aged investors, thereby combating inflation within the UK real estate market. These rules will come into effect gradually between 2017 and 2020, so it’s worth checking the sums to see if your investment will still be profitable in a few years.
Alternative Finance Sources
Part of the beauty of buy-to-let mortgages is that they can be obtained from many different lenders, just like with business loans. Because lenders don’t have to be regulated by the FCA there are many more options to choose from, and borrowers can turn to a wide variety of lenders which owner-occupiers can’t work with.
Bridging Finance
A mortgage is a long-term financial solution which often lasts for several decades. Whilst this allows borrowers to keep their costs down, the cumbersome checks which lenders need to carry out can often delay the purchase process, and when buyers need to act quickly it’s often necessary to turn to a faster, more flexible form of finance. “Bridging” loans fulfil this need precisely, because they provide a quick way of arranging payment - bridging loans are used to secure a property before obtaining a mortgage (they bridge the gap between making the purchase and finding a mortgage, hence the name).
Bridging lenders work much more quickly than mortgage lenders, and can often provide funds in as little as a week (or even faster, if necessary). However, bear in mind that bridging finance is only a short-term solution, and few lenders provide terms of longer than 12 months. You’ll ideally want to repay the loan as quickly as possible because bridging lenders charge monthly interest, which quickly mounts up.
Bridging loans are most often used when the property must be purchased quickly (when buying at auction, for instance) or is unmortgageable (if in need of renovation, or with a short lease). Talk to an experienced financial advisor before committing to bridging finance, because while these loans can be exceptionally useful, when handled poorly they can end up costing a lot of money.
Mortgage Brokers
There are many mortgage brokers in the UK who have access to the very best deals - they can go directly to a wide selection of different lenders and find the right deals for your situation. This can be invaluable when finding a buy-to-let mortgage, because as we’ve seen it’s more important than ever to get the cheapest deal possible. By getting an experienced professional onside you can quickly find a selection of great deals that suit your particular circumstances, rather than having to sift through hundreds of offerings from different providers.
Bear in mind that while a mortgage broker can help you find the best deals, they may not always cover the whole market for you. Some brokers only work with certain companies, while others will only offer mortgages from a selection of lenders (even “whole market” brokers only have to offer mortgages from a representative selection of lenders). Make sure you contact a trustworthy specialist UK mortgage broker to get the best deal on your buy-to-let mortgage.
Peer-to-Peer Mortgages
Peer to peer lending has seen huge growth in the last two years, and has quickly become the next big thing in finance. Even the big London players are getting involved, and it’s easier than ever to source funding through one of the many new P2P lending platforms, rather than through a bank. While no peer-to-peer sites are regulated to allow residential mortgages there are several which offer Buy-to-Let mortgages, such as Landbay and Proplend.
The idea of financing a buy-to-let mortgage through peer-to-peer finance might seem a stretch too far at first, but these sites have financed many millions of pounds worth of property over the course of several years. The big bonus for borrowers is that these sites have little infrastructure to support, and aren’t reliant on central banking to finance their mortgage products; this allows them to offer highly competitive interest rates compared to large high street lenders. If you’re considering a P2P-financed mortgage for your property be sure to thoroughly research this new and innovative source of finance before committing to it.
Buying a Second Home - What You Need to Know
The UK Government’s decision to crack down on the buy-to-let market has led to the introduction of several new measures designed to curb BTL investment. One of these measures is a change to the way Stamp Duty is charged on second homes: anyone who already owns a property will be liable for a 3% surcharge on the entire value of the property. This is a hefty sum, especially considering that the buyer will still need to fork out the regular Stamp Duty fee as well.
Owning a second home in any capacity makes you liable for the 3% surcharge, whether it’s a BTL property or your own home, and no matter where in the world it is. This is bad news for expats, as it means anyone who owns a home abroad will have to pay a significantly higher price for any property they buy in the UK. However, it is possible to claim a refund on this surcharge if you sell any other property you own within 3 years. For instance, if you own a house in Spain and decide to buy a home in the UK, you’ll have to pay 3% of its value in Stamp Duty. If you then decide to return to the UK permanently and sell your Spanish property you can reclaim this 3%, as long as it’s within 3 years of the initial purchase.
Interest-Only Mortgages
Almost all residential mortgages are what’s known as “repayment mortgages”. This means that the monthly payments made by the homeowners contribute both to the interest on the property and to repaying the initial loan. However, some buy-to-let owners aren’t really interested in building up equity in their property; the property is a business, and the owner has no desire to take over the home once the mortgage runs out. BTL mortgages can therefore often be obtained on an “interest-only” basis, where the borrower only makes repayments on the interest payable on the loan. This helps to keep costs down, which maximises the profits the landlord makes.
Of course once the mortgage expires, the whole loan will need to be repaid, and since no contributions have been made to the capital throughout the loan’s term this will be a significant amount. Usually, the mortgage holder will simply decide to sell off the property at this point, using the proceeds to repay the initial loan (and pocketing any profits leftover). It’s important to consider what you want from your property when deciding which type of mortgage to choose - if you would like to eventually own the property, a repayment mortgage might be the best choice. However, the best profits can usually be made by opting for an interest-only plan (and many couples choose to downsize into their BTL properties by selling their larger main residences, then using the proceeds to pay off their mortgage).
Buy to Let Mortgages in the UK
While the buy-to-let market has come under fire in recent years from the Government’s new legislation, the market still offers a highly competitive investment for those who can get the best deals. Buy-to-Let still offers investors a great opportunity to purchase UK real estate, and often compares favourably with other savings options.
