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Tuesday, Oct 19, 2021

Buy-to-let mortgages - how they work

Buy-to-let mortgages - how they work

Buy-to-let (BTL) mortgages are for people who want to buy a property before renting it out to tenants.

BTL mortgages are similar to residential mortgages for owner-occupiers, but there are some key differences it’s important to be aware of.

What’s a BTL mortgage and who needs one?

You might need a BTL mortgage if you are a first-time landlord or professional property investor. Traditional residential mortgages are only for borrowers who will actually live in the property.

If you rent out your property that’s been paid for with a residential mortgage, you’ll likely be breaking your mortgage agreement (unless the lender has agreed to a temporary consent-to-let).

How does a BTL mortgage work?

Essentially, it works in the same way as a more common residential mortgage. It’s a home loan that allows you to borrow a sum of money to buy a property which is then paid back, plus interest, in monthly instalments over a set number of years.

Like residential mortgages, the interest rate on a buy-to-let mortgage can be either fixed or variable. A fixed-rate guarantees that your interest rate and payments remain the same during the fixed term. With a variable rate mortgage, the interest rate can go up or down.

Deposit requirements

The minimum deposit for a buy-to-let mortgage is usually 25% of the property’s value, although this figure sometimes rises up to 35% if you are buying a flat or new build bricks and mortar. This is significantly different to residential mortgages where it’s often possible to put down a deposit of as little as 5% of the purchase price.

Each buy-to-let mortgage will have a maximum loan-to-value (LTV). This is the maximum proportion of the property’s value you can borrow as a mortgage.

The bigger your deposit, the lower the LTV. The lower your LTV, the cheaper your mortgage will generally be. The buy-to-let mortgages with the lowest rates, will carry a maximum LTV of 60%. This means you’ll need a 40% deposit to get the best deals.

Loan calculations

When deciding how much money landlords can borrow, BTL mortgage lenders look at the rental income a property can generate, rather than the landlord’s income from their job.

Affordability is calculated using an ‘interest cover ratio’ (ICR). The ICR is the minimum ratio between the expected rental income of the property and the landlord’s mortgage payments, tested at a representative interest rate (normally 5.5%). This is called a ‘stress test’ as most mortgage interest rates won’t be that high.

Most mortgage lenders require a minimum ICR of 125%, although some may require an ICR of up to 145%. For example, if a landlord’s mortgage payments are £1,000 a month, for an ICR of 125%, the rent being charged will need to be at least £1,250 a month. If the ICR is 140%, the rent will need to be a minimum of £1,400.

If the rent is insufficient for the required ICR, some lenders will allow the landlord’s personal income to be taken into consideration.

What do BTL mortgages cost?

Product or arrangement fees on BTL mortgages tend to be higher compared with residential mortgages. Some products will have a flat fee, while others will charge a percentage of the loan amount.

In general, a flat fee works out best for large loan amounts, and a percentage fee better for smaller mortgages.

Interest rates on buy-to-let mortgages are usually higher than on residential mortgages. This is because lenders view landlord mortgages as riskier than mainstream loans.

The interest rate you pay will depend on the LTV, the expected rental income, and your personal circumstances. Interest rates can be fixed or variable.

Repaying a BTL mortgage

While most residential mortgages are agreed on a repayment basis, buy-to-let loans are usually offered on an interest-only basis.

With an interest-only mortgage you only pay the mortgage interest each month, not any of the capital. This means cheaper payments, but at the end of the mortgage term you’ll still owe the amount you initially borrowed.

Some buy-to-let investors choose interest-only because the lower monthly payments make it easier to meet the ICR required. There is also the option to sell the property at the end of the term and repay the capital borrowed from the proceeds.

How do you qualify for a BTL mortgage?

Some mortgage lenders will only lend to landlords who already have a residential mortgage in the UK. However, a handful of providers will lend to first-time buyers whose first property purchase is for rental purposes.

Some lenders will only lend to landlords over the age of 25. It’s also common to have a maximum age limit when the mortgage is due to end. So, if the age limit at the end of the term is 80yo and you want a 25-year term, you’ll need to be 55 or younger to be eligible.

Some lenders also require you to have a minimum personal income of £25,000, while almost all will only lend to borrowers with a good credit record.

The property you’re buying will need to be in good condition and be let as a single unit, rather than per room on a multiple occupancy basis. You’ll need a different type of buy-to-let mortgage if you let a house in multiple occupation.

Mortgage brokers and BTL

Certain high street banks offer buy-to-let mortgages, but a smaller specialist lender might offer you a better deal. In this instance, it’s worth considering using the services of a mortgage broker. Brokers will know the best lenders to approach for your deposit level, property type, and personal circumstances.

A broker can also work out the best deal for you based on various fee/interest rate combinations. He or she can also advise on the extra tax implications associated with being a landlord. For example, from receiving rental income or on various aspects of stamp duty, the graduated tax that’s paid on property transactions.


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