Buy To Let Mortgages
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Richard Campo shares his expertise on Buy to Let mortgages.
What is a Buy to Let mortgage and how do they work?
It’s where you own a property but you want to rent it out to somebody. The driver for a Buy to Let mortgage is the rental income. When you’re buying property for you and your family, the mortgage is based on your personal income, while Buy to Lets are based on the rental income. There are some very complicated calculations involved but that’s basically how it works.
How is a personal Buy to Let different to a limited company Buy to Let?
Limited company Buy to Let goes back a long way, and banks moved away from it in the 1980s because a lot of people were setting up limited companies, buying property, then folding the companies and taking the assets. So banks were a bit burnt in that area. They fell out of vogue in the 1990s because of tax treatments, but now they’re coming back in a big way.
A personal Buy to Let is not very tax efficient if you’re a high rate taxpayer. You pay tax on all the rental income and you can’t offset all your costs. Previously, you could offset all the interest and only paid tax on your profit, whereas now you’re paying tax on the total rental income. Hence the popularity of limited company Buy to Let for high rate taxpayers, because they only pay corporation tax, currently at 19%. So we urge you to get tax advice before you go down either path. We have some great contacts for that if you need them.
In terms of the pros and cons, personal Buy to Let rates are cheaper, but you’re subject to more tax. With limited companies, interest rates are a bit higher at the moment – but I wouldn’t be surprised if the costs become comparable over the next few years.
There are some extra benefits to limited company borrowing too – transferring assets to children or other people is easier, for example.
Who can get a Buy to Let mortgage?
The answer is pretty much anyone. If you don’t own a property it can be a little bit more tricky. Some banks will do a background sense-check on this, because in the past, certain people with a cash sum but a small income would get a Buy to Let property and live in it – even though they technically couldn’t afford the home.
If you own a property already, banks are more relaxed. Also, if you’re an experienced landlord, with at least one Buy to Let for more than 12 months, banks become more liberal still because you’ve got a track record.
How much can I borrow on a Buy to Let and what deposit do I need?
Technically you can get away with a 15% deposit but this does change. The norm is a 25% deposit. As with any mortgage, the bigger deposit you put down, the lower the interest rate. With Buy to Let, a 50% deposit will get you the cheapest rates.
For some of the tax reasons we mentioned, some people do prefer to borrow more on Buy to Let, but that’s a conversation to have with your accountant.
To see how much you can borrow, a bank will look at the rental income you’ll receive. They’ll mainly do two things. One is a ‘stress test’ looking at what happens if interest rates increase over time. Interest might be 2.5% now, but the stress test is at 5.5%.
On top of that, they do something called an ICR, an interest cover ratio. I’ve worked out that if you go through that standard calculation, for every £1,000 of rental income you get around £15,000 worth of borrowing.
There is also something called top slicing, which is something we do a lot now. What you’ll find particularly in London and the South East is that it’s really tough to meet those requirements. If there’s a shortfall in the calculations, some banks will allow your personal income to be included to top up the numbers. It’s a way to get bigger loans in London and the South East.
If you’re a portfolio landlord it’s different again, and the lenders will look at all your properties to see whether you are borrowing more than 150% of your rental income. It’s a complex area, so do seek expert advice from a broker.
What are the costs involved in buying a Buy to Let property?
As with a regular mortgage, you’ll have legal charges, surveys, lender fees and arrangement fees. We’ll calculate the total cost of borrowing for you. For example, on a two or a five year fixed rate mortgage we’ll crunch all the numbers and recommend the most effective way to achieve your plans.
The challenge with a Buy to Let specifically comes if you don’t fit that rental calculation. So perhaps one lender is cheap, but they’ll only offer you a certain size of mortgage. Meanwhile a second lender will offer you a larger loan, with a slightly higher cost.
Another important consideration is the stamp duty. If you own one property already and buy a second or third, you will pay a 3% surcharge on the normal stamp duty rate each time. An online calculator will help you understand what that means in real terms. The rules are slightly different with limited companies, too, so seek tax advice.
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Is it illegal to rent out a house without a Buy to Let mortgage? Is it illegal to live in your own Buy to Let property?
It’s not illegal, but you would be breaching your mortgage conditions. One bank actually got in trouble for this recently, where they weren’t classifying their loans correctly – some were described as residential when they weren’t.
As we touched on earlier, banks don’t want you to use Buy to Let to take out a bigger loan than your income allows. Plus, Buy to Let loans are more risky to the bank. They go into arrears and repossession more often because they’re a business venture and people are less emotionally attached. The Financial Conduct Authority therefore asks banks to keep more capital on their balance sheets for Buy to Let lending. That’s why banks don’t like you muddying the waters.
If you breach your conditions, a bank can penalise you financially. Halifax, for example, will charge you the Standard Variable Rate plus 1%.
Should I choose interest only versus repayment on a Buy to Let mortgage?
This is something I specifically talk to my clients about – to explore your goals. People generally have two main purposes with a Buy to Let: capital appreciation or income in retirement.
With capital appreciation, it’s all about holding a property so that its value increases at a rate above inflation. People hold their Buy to Let property for 10, 20, 30, 40 years then sell it and keep the cash. In that case, go interest-only because that will fill your requirement.
If you want to generate income into retirement, it might make more sense to set it up as a repayment mortgage. Get the tenants to pay off your mortgage and then when you retire you receive all the rental income – plus you don’t have to worry about trying to get a mortgage when you’re older, which can be more difficult.
How many Buy to Let properties can I own? Is there a limit?
No, not at all, in fact one of my favourite podcasts is from Rob Moore who has over 150 properties now. The only limitation is the money you can put into it because as we say on average, you need a 25% deposit for a Buy to Let so it is quite capital-heavy.
If you do own more than five mortgaged properties you then become what’s called a portfolio landlord. A lot of high street lenders tap out at this level as they don’t want to deal with portfolio landlords. If you have more than five we usually start talking to commercial lenders.
That means we will need business plans, cashflow, forecast rent rolls etc. It’s not a problem, it’s just a different way of working.
An interesting technical thing is that the limit is specifically five mortgaged properties. If you own 10 properties and only three have mortgages on them, you wouldn’t be viewed as a portfolio landlord from a regulatory perspective. It’s mortgaged properties not properties in totality that you own.
What advice do you have for someone interested in Buy to Let?
It is a very technical area and it is more akin to a business than buying your own home. It’s really important to talk to a broker as it can be very complicated. Plus, brokers have more access to products – we get lots of exclusives and well over 90% of all Buy to Let lending comes through Brokers. We have access to banks that don’t deal direct with the public.
If you’re not talking to a broker, you’re not going to get the best outcome. We’re here to help you through this. We’ll make sure you’ve looked at all the options so your Buy to Let will achieve your goals.
The Financial Conduct Authority does not regulate most Buy to Let Mortgages
Your home may be repossessed if you do not keep up repayments on your mortgage or any other debt secured on it.