buy to let mortgages

Buy to Let Mortgages

explained

If you are lucky enough to be in a position to become a landlord before you take the plunge there are many factors you need to consider. The first thing to note is that most mortgage companies will require you to finance the property with a specific buy to let mortgage. If you are vacating your property for a short period (say for 6 months because you are going abroad with work) and wanting to rent it out then your mortgage company may allow you to just remain on you normal residential mortgage deal. If you want to do this you should always ask your mortgage provider first however if you aim to rent a property out for an extended period you should get a specific buy to let loan.

Many features of buy to let mortgages differ greatly from regular residential loans and can seem confusing at first. Here we'll try to explain the main features and areas that differ from the average residential mortgage:

Higher LTV (Loan to Value) for buy to let mortgages

This is a simple calculation that mortgage providers make in order to reduce the risk of their loan to you. It can be thought of as the deposit which you must put down on the property in order for them to lend you the remainder. Buy to let mortgage lenders will usually require a much higher LTV than on regular mortgages. Lets look at an example:

Lets assume the property you want to purchase is worth £100,000. You approach a mortgage company who state their maximum LTV is 85%. This means the maximum the mortgage company will lend you is £85,000 (£100,000 x 85%). In other words you must have a deposit of £15,000 in order to buy the property. In reality you will require more than that as you'll also have to factor in the extra expenses such a legal fees, land registry charges and potentially the cost of any planned renovations.

Traditionally buy to let lenders set LTV limits quite high, traditionally around the 75% mark. However the explosion of buy to let landlords in recent years has led to much greater competition in the market, which in turn has forced lenders to now regularly offer loans at an LTV of 85 or 90%, with some even going as high as 100%.

As usual there is a pay off. Generally the lower the LTV of the mortgage the better the interest rate you will receive. Obviously the higher your deposit is compared to the property value, the less risk there is for the mortgage lender of them repossessing a property that is worth less than the outstanding loan, hence they'll be more willing to offer you a more competitive interest rate.

Interest only Vs Repayment

One huge factor to consider is whether to go interest only or repayment. Many landlords opt for interest only buy to let mortgages, the reason being considerable tax benefits are available. Lets look at an example:

Assuming I rent a property for £700 per month and my repayment mortgage payments are £400 per month. By law I must declare this income to the tax authorities so therefore (assuming i pay tax at the higher rate of 40%) I would effectively have to pay £280 per month in taxes (£700 x 40%). However there is a rule whereby the interest paid on a mortgage is tax deductible. Assuming my £400 repayment is interest only, my taxable income would be £300 (£700 - £400), leaving my monthly tax bill at only £120 (£300 x 40%).

In the first example where I had to pay £280 per month in tax the £400 repayment would have a small element of interest charge in it so the figure might have been slightly under £280.

One important thing to remember is that if on an interest only deal you're not actually paying off the loan so at the end of the mortgage period you'll be expected to pay off the original loan in full. Most people however take an interest only loan out on the assumption that in the long term the property will increase in value allowing them to sell the property at a profit at the end of the term.

Minimum Rental Income as a % of mortgage payments

This is another criteria often set down by mortgage companies on buy to let loans. Lets look at an example:

You mortgage company may stipulate for rental coverage of 125%. This would mean that your expected monthly rental income should be 125% of you monthly mortgage repayment. In our example above we were borrowing £85,000. Let us assume a max LTV of 85%, an interest rate of 6% and a minimum rental coverage of 125%:

Cost of Property: £100,000
LTV = 85%
Max loan offered: £85,000
Interest rate: 6%
Monthly repayments: £425 (£85,000 x 6% / 12 months)
Required rental coverage: 125%
Minimum rent required: £531.25 (£425 x 125%)

That said it is often best to build in a bit of slack into your calculations for any unexpected events. For example it is common to have say 1 month per year with no rental income if the property is empty after a tenant moves out while you are looking for a new tenant. Alternatively you might need to spend some money repairing the property or replacing fixtures and fittings, all of which can soon swallow up a month or twos profit.