What is a buy-to-let mortgage?

, by Matt Stevens

A buy-to-let mortgage is a specialised type of mortgage agreement designed for prospective landlords who want to buy a property and rent it out to tenants, but can’t afford to buy it outright using their own capital or savings. As with a traditional mortgage, a bank or building society will fund the purchase, and the borrower pays back the debt (or the mortgage interest) in monthly instalments across the agreed mortgage term.

The key difference between a buy-to-let mortgage and a residential mortgage is that the borrower buys the property with the intention of letting it out to tenants. In other words, you’ll still retain the ownership rights to a property, but you won’t be able to live there yourself without consent from your lender.

While a residential mortgage helps borrowers to buy a home to live in, a buy-to-let mortgage is primarily a form of investment. Landlords use the property to generate rental income, which is used to cover the cost of the monthly mortgage repayments, maintenance and insurance, and a profit. Landlords can also make a capital gain by selling the property, assuming that the property continues to increase in value during the mortgage term. Read on to find out:

How do buy-to-let mortgages work?

Buy-to-let mortgages work in a similar way to residential mortgages: you’ll receive a loan to cover the purchase price of your property, and make monthly payments to your lender over the agreed term. There are two types of buy-to-let mortgage: interest-only and repayment.

Interest-only buy-to-let mortgages

Like any loan, a buy-to-let mortgage is made up of two sums: the principal (the amount borrowed to cover the purchase price) and the interest (the borrowing fee charged by the bank or building society).

With an interest-only buy-to-let mortgage, you’ll pay back the interest owed each month, but not the capital borrowed. This means that, after the agreed term ends, you’ll need to pay back the full capital amount, either by selling, remortgaging, or using other assets or savings to pay off the remaining debt.

Most buy-to-let investors opt for interest-only mortgages because this helps to keep their monthly outgoings as low as possible. They’re also a popular choice with investors who are looking to build a large portfolio, as it allows them to build up a lucrative cash flow which they can then reinvest.

If you don’t have a way to pay off the remaining debt when the agreed term ends, you’ll need to either remortgage or sell the property. This is why many buy-to-let investors will choose properties they think will increase in value, as this will result in a capital gain when they sell up. Of course, given that the housing market is always fluctuating, it can never be guaranteed that a property will retain or increase its value, so there’s always an element of risk.

Repayment buy-to-let mortgages

With a repayment buy-to-let mortgage, you’ll pay both the interest and a portion of the capital each month. This means that, at the end of the term, you’ll own the property outright and won’t need to pay off the capital. However, this does mean that your monthly outgoings will be higher.

Repayment buy-to-let mortgages are a more popular option for investors with just one or two rental properties, because there’s no need to worry about repaying the capital at the end of the term. But, they do usually involve higher monthly payments, so it will be less profitable for the duration of the loan.

Ultimately, the best mortgage type for you will depend on your own personal investment strategy and long-term goals. Your financial advisor and mortgage broker will be able to help you work out which is best for your circumstances.

Are buy-to-let mortgages regulated?

Buy-to-let mortgages are essentially investment schemes and are classed as a type of business transaction. As such, they aren’t regulated by the Financial Conduct Authority (FCA), and the rules and regulations around this type of mortgage are very different to a standard mortgage.

Standard mortgages are for borrowers seeking a residential property, and there are a number of protections and affordability regulations in place to help limit the possibility of the borrower losing their home. This means that every stage of the borrowing process is controlled and regulated by a strict set of rules, which the lender must follow.

As buy-to-let properties are treated as investments, the protections and regulations which help to shield residential homeowners do not apply to buy-to-let mortgages. Professional landlords are not perceived to need the same supervision and protection as ordinary consumers, and so the affordability tests are less stringent. There are also less protections in place to protect buy-to-let landlords who get into mortgage arrears.

There are a few exceptions to this rule. For instance, if you are buying a property with the intention of renting it out to a close relative, this will be classed as a ‘consumer buy-to-let’ and will be regulated in the same way as a residential mortgage. So-called accidental landlords — those who have acquired a rental property through marriage or an inheritance — can also qualify for FCA regulation, provided they can prove they didn’t buy the property with the intention of becoming a professional landlord.

Changing your mortgage to a buy-to-let

There are lots of reasons for changing a mortgage to a buy-to-let: you may have a home under a traditional residential mortgage sitting empty, or you might wish to move to another property and rent out your current home. Residential mortgage agreements don’t allow borrowers to let their homes during the term of the mortgage, which is why you’ll need to contact your lender if you want to start charging rent.

One option is asking your lender for a ‘consent to let’. This is where your mortgage provider agrees to let you rent out your home for a set amount of time, and is usually allowed if the property will only be let for a short period — while the owner is travelling, for instance. Occasionally, lenders will allow you to rent out your home without raising the rates, while others will insist that you switch your mortgage to a buy-to-let agreement.

Your current lender may agree to transfer your existing mortgage to a buy-to-let mortgage, but that doesn’t necessarily mean that you’ll be offered a competitive rate. So, you’ll want to shop around to find the best deal. Get in touch with our professional brokers on 033 33 44 33 72, who will be able to crunch the numbers and find the right buy-to-let mortgage for you.

Can I get a buy-to-let mortgage?

If you want to get a buy-to-let mortgage, then you’ll need to satisfy the provider’s lending criteria. While lenders will look at things like your salary, spending, and deposit, they’ll also scrutinise the potential rental income of your property.

Buy-to-let mortgages present a bigger risk to lenders than residential loans, as borrowers are more likely to fall into arrears. This means that the lending requirements for buy-to-lets are stricter than the standard eligibility criteria for ordinary residential mortgages. Here, we’ll discuss exactly what you need for a buy-to-let mortgage to give you an idea of your chances of being approved.

Rental income

Banks and building societies will only ever issue a buy-to-let mortgage if they think you can afford the repayments. To assess this, lenders will use something called the rent-to-interest (RTI) cover calculation (also sometimes called an interest cover ratio, or ICR). This works out the ratio of potential rental income to the total interest payable across the full term of the mortgage, giving lenders a rough estimate of your ability to cover the cost of the repayments.

Essentially, this means that your lender must be confident that the property will earn enough rental income to cover the cost of the loan. To try to get an accurate idea of how much this will be, the lender will carry out a valuation of the property and work out an estimated rental income based on the current rental rates for similar properties in the area. This is then balanced against the total annual interest of the loan, creating the RTI rate.

The exact RTI rate varies between different lenders, but most will require an estimated rental income of 125%–140% of the mortgage repayment before they’ll approve the loan. The substantial percentage difference provides a financial buffer, to help stop the borrower from getting into arrears should something effect their rental income. It also allows some leeway for periods when the rental property may be vacant.

Salary

If you’re a first-time buy-to-let investor, lenders will look at your other forms of income in addition to the RTI ratio. Many lenders will require that you earn at least £25,000 before they agree to give you a loan. This is because your salary will act as financial safety net should your tenant fall into rent arrears, or if your property is left vacant between tenancies.

Age

To ensure that you’ll be able to cover the repayments for the full duration of the term, many lenders enforce an upper age limit for buy-to-let mortgages. As such, most lenders won’t accept applicants over the age of 75 although, under certain circumstances, some lenders will consider applicants up to 85. Some lenders will also insist on a minimum age of 25, as statistics show that younger applicants present a substantially higher risk.

If you’re taking out an interest-only loan, remember to think about how old you’ll be when the term ends and how you plan to pay back the remaining debt, as you may you may struggle to get a remortgage once you are over the upper age limit.

Deposit

As with any other type of mortgage, you will need to pay a deposit. Buy-to-let mortgages are riskier for lenders than residential mortgages, and this is reflected in a higher deposit amount. While the average deposit in the UK is around 16%, you can expect to pay around 20–40% of the property value for a buy-to-let, depending on the amount you want to borrow and the RTI ratio.

As with a residential mortgage, you’ll almost always be able to access better rates if you have a bigger deposit. So, while saving for larger deposit will take longer, it could help you to maximise profitability in the long run. You can learn more about this, including ways to save, in our deposit guide.

How many buy-to-let mortgages can I have?

There is no cap on the number of buy-to-ley mortgages you can have, although lenders may set different limits on the number of mortgages you can take out with them. The bigger banks and building societies will normally allow borrowers to take out around 3–5 buy-to-let mortgages, but they’ll apply their own unique risk assessment in each case. Some lenders will place no limit on the number of mortgages you can have but will cap the total amount of money you can borrow across all of your loans.

Many investors will spread their portfolio across different mortgage providers. There’s no legal limit on the number of mortgages you can have with multiple lenders: in fact, many investors with very large property portfolios may have hundreds of mortgages. At any rate, you’ll need to provide evidence of your existing portfolio of buy-to-let mortgages (sometimes called your ‘background properties’) when you approach a new lender for a mortgage.

How much is the deposit for a buy-to-let mortgage?

The deposit for a buy-to-let mortgage is larger than it is for a residential mortgage. Buy-to-let mortgages are classed as a business transaction, which means that the deposit amount required to take one out is usually higher than it would be for a standard mortgage. The minimum deposit amount is usually around 25% of the property’s value, although it may be as low as 20% and as high as 40%.

What are the fees and costs of a buy-to-let mortgage?

Buy-to-let mortgages present a higher risk than residential mortgages, both for the borrower and the lender. As a result, mortgage rates on a buy-to-let product are almost always higher than they would be for a typical residential mortgage — generally by around 1–3%. The various mortgage fees, including admin and arrangement fees, also tend to cost more. The exact figures vary according to both the lender and the product, so remember to weigh up all the fees and costs when comparing.

How much can I borrow using a buy-to-let mortgage?

There’s no upper limit on how much you can borrow using a buy-to-let mortgage. Exactly how much you can take out is up to the discretion of the lender, who will base their judgement on the usual lending criteria. Buy-to-mortgages may run from a few thousand pounds to in excess of a million — the only real limit is what a lender judges to be worth the risk.

In terms of what loan to value (LTV) you can expect, it’s possible to find buy-to-let mortgages with around 85% LTV, although the majority of rates available offer 75% LTV. Lenders won’t lend more than this as there’s no guarantee that your investment will retain, or increase, it’s value.

Can I remortgage a buy-to-let property?

Almost any property can be remortgaged, including buy-to let, as long as you’re not in negative equity and can satisfy the lender’s eligibility criteria. Many landlords decide to remortgage their properties in order to free up equity, or to lock down a cheaper rate. Those on interest-only mortgages may also opt to remortgage their property to extend the loan once the agreed term ends.

For many rentiers, remortgaging can be a lucrative way to cut monthly overheads and maximise profit. But, as with any other type of mortgage, you may have to pay an early repayment fee if you decide to switch before the fixed-rate period ends. So, your remortgage should be carefully timed.

Can I live in a buy-to-let property?

If you decide that you want to live in a buy-to-let property that’s still under mortgage, then you will need to request permission from your provider. It’s likely that the terms of your buy-to-let mortgage stipulate that your property must be let to tenants, so if you move in without informing your lender, you would be breaching the terms of the contract. Breaking the terms of your agreement will mean that your lender can invoke their right to call in the full value of the loan, so it’s best to be upfront and ask for consent.

If you want to live in your buy-to-let property for the long term, then it’s well worth considering switching to a residential mortgage. These are regulated by the FCA, so you’ll have more protections in place, and you may even be able to access cheaper rates, too.

Can I get a buy-to-let mortgage as a limited company?

Many landlords and property investors choose to buy property through a limited company, instead of as an individual. Buying through a private company is often a better model for investors with larger portfolios, and it can also make paying tax on your earnings more efficient and affordable.

When you buy property as an individual, your rental profits will be added to anything else you earn (like a salary from your job) and you may need to pay income tax on this figure. As a limited company, you’ll pay Corporation Tax — this is currently fixed at 19% (Gov.uk). So, you need to calculate which option is most cost-efficient for you.

The recent changes to tax relief for landlords have also made buying property through a limited company more appealing. Until April 2017, landlords could offset their mortgage interest against their rental income before calculating their tax liability. But the government is currently phasing out this relief, and by 2020 it will have been completely replaced with a 20% tax credit, which is far less generous than the previous relief system. Those who pay income tax at the higher rate could lose thousands of pounds.

However, this only applies to those buying property as individuals. Limited companies pay Corporation Tax, which is fixed, and so won’t be affected by the relief changes. As a result, many rentiers are forming limited companies solely for the purpose of buying property. You also won’t need to pay income tax if you decide to reinvest your profits into new properties and, as Corporation Tax is fixed, you may benefit from the effects of compounding, which can lead to excellent long-term profits.

But, becoming a limited company isn’t necessarily a guaranteed fix. There are other costs involved in becoming a limited company, and you’ll need to pay higher rates of stamp duty on buy-to-let purchases, too. So, you’ll need to do your research and consult a professional to help you balance the books and work out which is the best decision for you.

There’s also the issue of admin: owning a limited company can be a lot of work. You’ll need to spend more time handling your accounts and submitting tax returns, or hire an accountant to handle this on behalf of the company. But, if you’re serious about expanding your property portfolio and maximising your rental income, it could be the right path for you. You can learn more about forming a limited company on the government portal.

We hope that this guide has helped you to get a better understanding of what a buy-to-let mortgage is and how they work. Remember, when investing in rental property, it’s essential to find the best possible mortgage rates, as this will help you to maximise your profits in the long term. That’s why it’s so important to consult a broker before deciding on a buy-to-let mortgage product.

Here at The Mortgage Genie, we offer expert buy-to-let mortgage advice that’s specifically geared towards aspiring and existing landlords. We can offer financial advice that’s tailored to your goals, and we may even be able to help you access special products and one-off rates that you won’t find anywhere else. So, whether you need help finding a loan for your first investment or you need to change your current product to a buy-to-let mortgage, our knowledgeable team of advisors will be able to help. Simply get in touch to kickstart your property portfolio today.

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