Financing Property – Buy-to-let mortgage considerations
The second episode of the Buy to Let Show looks at what landlords need to consider when financing and insuring a buy-to-let property. Plus, property expert Kate Faulkner provides a breakdown of what landlords need to know about mortgages.
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What's different about buy-to-let mortgages?
Financing a buy to let is very different to financing a home. Buy-to-let mortgages are considered by lenders - and their regulators, the Financial Conduct Authority - very different to taking out a mortgage for a home you own and live in.
As a landlord, you're effectively running a business, so buy-to-let mortgages are seen as commercial lending.
So, as a business:
- Rent is considered to be your revenue.
- Your costs are those expenses incurred to make sure the property is in a fit state to let to your customers, i.e. your tenants.
- You will be expected to know how to let the property legally and safely.
When lenders consider whether or not to provide a mortgage for a buy to let, they look at the risks involved:
- This typically requires a higher deposit than if buying a home of your own.
- You're likely to pay higher mortgage rates than a home owner.
- The buy to let needs to be financially viable through good times and bad.
- Lending will be assessed not so much on your ability to afford the property, but its ability to fund itself and make a profit.
- Lenders will require independent views on the rent achievable and will expect this to cover the cost of the mortgage by anything from 125% to over 160%.
All lenders will have different criteria for lending on different types of buy to let. Some lenders are happy to lend to landlords who want to rent rooms, while others prefer professional lets. Some lenders will let you borrow money from them if you want to renovate or change a property - for example from a house to flats which you then let. However, others may only be interested in lending on existing homes that are rented out to professionals.
Due to the complexity of buy-to-let mortgages, most lenders offer their mortgages through brokers instead of directly to existing or new landlords. If you want a choice of mortgages, you will need to go through an experienced mortgage broker.
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How to finance a buy-to-let property
Rupert Swetman from Which? Mortgage Advisers explains that lenders view buy to let as a higher risk than someone living in a home for which they have a mortgage.
As a result, they typically ask for a higher deposit and will 'stress test' your buy to let to make sure that the rent exceeds your costs, so the let is more likely to be successful. This may also include checking your own earnings in case you need to fall back on them to pay the mortgage. This could happen if your tenant stops paying for any reason or if the property is left empty.
Swetman also explains that securing a buy-to-let mortgage through an experienced broker is the ideal way to finance a property to let. Although some lenders will lend directly to landlords, the majority prefer to offer their mortgages through a broker. They will have the time and experience to assess the proposed let and make sure that the right lenders are approached who will support the type of buy to let you would like to invest in.
This is more important than ever before as some lending is classed as 'commercial', such as buying a new property which you then let out, while other lending is classed as 'consumer'.
For example, if you want to buy property specifically to let and earn income from, this is classed as 'commercial lending'. If you let a property that's been inherited or a property previously lived in, this is classed more as 'consumer' lending. If it's consumer lending, the implications are that you will have to provide more evidence given it's affordable, based on salary, not just the rent covering your income.
Finally, it might be that you need to move fast to purchase the buy-to-let property to secure a discount. In this case, a broker is particularly useful as they know how long different lenders take to assess an offer.
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How buy-to-let mortgage criteria differ from residential mortgages?
When a lender agrees to offer you money to buy a property, they will often put caveats in place that suit them, referred to as 'lending criteria'.
Typically, buy-to-let criteria differ from the criteria of buying a home to live in. This is because banks need to factor in the perceived increased risks of having relatively 'unknown' tenants in a property. For instance, lenders will normally ask for a larger deposit (read more below).
Plus, mortgage rates tend to be higher to cover the greater risk of non-payment due to rent not being paid, or problems with the property being empty, which could be due to local oversupply or the property needing major repairs.
Also, because buy to let is a business and not a property you would own and live in yourself, some lenders restrict the age you can purchase a buy to let. You may have to be over 25 or they may not lend to those who are retired or over 75.
Finally, in view of the time invested in lending on buy to let, some may set minimum purchase prices, such as in excess of £60,0000.
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Buy-to-let mortgage deposits
Buy-to-let deposits are often higher than required when you purchase a home and the main reason for this is the increased risk.
To cover the increased risks, lenders will normally ask for a larger deposit. A first-time buyer may only need a 5% deposit. However, for a buy-to-let investor it's tough to secure a property that will be cash-flow positive with less than a 25% deposit. In more expensive areas you may need even more.
For example, if you borrow money to put a roof over your head, then it's likely you will do everything you can to keep it and pay the mortgage. A tenant, however, may leave a property if it suits them with only a few months' notice, which may mean as a landlord you struggle to pay the mortgage if a new tenant isn't moved in quickly.
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Choosing the right buy-to-let mortgage for you
The main way to choose the right mortgage is to find a broker that is experienced in buy-to-let investment and knows which lenders to approach on your behalf. This can save weeks of time and effort and may mean you secure a mortgage which you might not have been able to do on your own.
To choose the right mortgage broker, you can meet with a broker free of charge. This allows you to ask them questions to see if they can deliver not just the lending you need, but the level of service too.
For example, they should take time to understand what your property investment objectives are and offer mortgage products from the 'whole of market' and not just offer loans they get commission on. Next, make sure they can manage buying to a deadline, particularly if you're hoping to pick up discounted deals in return for buying quickly.
Once you're confident they can deliver, then check how they charge and how much. Some charge a flat fee while others will charge a percentage based on the value of the property/loan.
It's also worth making sure the mortgage meets your personal and business needs. For example, will they lend to you based on your age, the deposit you have, and your job, especially if you're self-employed? If you want to let to professionals, those on benefits, or specialist lets, it's also important that the lender will support the type of property you believe will help you achieve your objectives.
And of course, there are financial considerations that you'll need to bear in mind. These include:
- mortgage costs
- whether you can choose your own legal company of if you have to have one on their 'panel'
- the terms of the mortgage
- repayment versus interest only
- the mortgage rate
- any redemption penalties that may apply
- the level of deposit they would require
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Who can get a buy-to-let mortgage?
Depending on the lender, you may not be able to secure a buy-to-let mortgage. This may be the case, if, for example, you don't fall into their required age bracket or don't meet their rental expectations and income requirements.
Anyone who is self-employed or has a country court judgement (also known as a CCJ) against them is likely to struggle to secure a buy-to-let mortgage. However, there are lenders that will support you in this instance, they may just require a higher deposit and potentially a higher mortgage rate.
Plus, it can depend on the type of let for which you're looking. Letting to professionals is considered the least risky, while some lenders actively won't lend if you want to let to someone on benefits, for example.
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How much can you borrow for a buy-to-let investment?
When you're borrowing money to buy to let, it's essential to explain to the broker your plans. You may be just looking at a mortgage to let your home until a time when you'd like to sell it, or your plan might be to buy your first property, then use any equity growth to buy another until you build a portfolio of properties.
The reason this is so important is that some lenders actually restict the number of buy-to-let properties they will lend on. If you've got a clear investment objectives, it can mean the broker can secure you a 'funding line' that allows you to purchase a number of properies which allows you then to remortgage at low or no cost when you can secure more equity to purchase more.
As previously mentioned, lenders may also place a 'minimum price' on buy-to-let properties. Others may place a restriction on how much you can borrow from them over time which, if you are successful, may prevent you from buying more property until new funds are sourced.
So the trick to getting buy-to-let finance right from the start is being very clear about your investment strategy, so the broker can be upfront about whether you can borrow the money you want. It also gives the broker an idea of which lenders will be able to help you achieve your property objectives.
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Buy-to-let remortgage advice
Many buy-to-let investors are deciding to remortgage. This is because mortgage rates are accessible at around and some even below 3% in 2017, when 10 years ago they were double this amount (source: http://www.telegraph.co.uk/personal-banking/savings/latest-interest-rates-predictions-first-rise-in-august-2019/).
According to the Council of Mortgage Lenders, in January and February 2017, almost double the number of buy-to-let loans were remortgaged, versus new loans taken out https://www.cml.org.uk/news/press-releases/february-2017-monthly-lending-trends/.
When remortgaging, or even when you're taking out a new mortgage, it's essential to be clear on your objectives. It can help to talk these through with a broker who can advise on the best next steps which will allow you to downize or expand your portfolio, or just get you on the lowest rates for a fixed longer period (usually more than three years).
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And one last tip
As well as working with a mortgage broker, it's vital to seek independent financial advice, including property tax help. This ensures you aren't just buying and letting property, but making sure your investment is performing well versus other investments and you're mitigating tax where possible.
To do this successfully, you need to keep tabs on all your costs. These can include travelling to and from properties, property-related books you purchase to help with your buy-to-let plans and management, and costs such as agent fees, special landlord insurance and any maintenance costs.
Treating your property investments like a business, financing it correctly and paying the right amount of tax, so you're fully aware of your income and costs, are some of the most important ways of making sure your buy to let is successful.
Kate Faulkner
Last Updated: 13 July 2017
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