Buy to Let mortgages explained
Buy-to-let is a popular investment but with tax changes imminent and the cost of buy-to-let mortgages higher than conventional mortgages, it is more important than ever to do your homework.
What is buy-to-let?
Buy-to-let is a home which is purchased to let out in order to produce a rental return and income stream. It can also grow in value, producing capital gain when you sell. The rent on a buy-to-let property should cover:
- the cost of the mortgage
- expenses, typically building insurance, repairs and any letting agent’s fees
Buy-to-let and tax implications
Stamp duty – As from 1st April 2016, an additional 3% will have to be paid on every stamp duty band on any buy-to-let purchase.
This means the stamp duty on a buy-to-let home costing £250,000 will soar from £2,500 to a massive £10,000.
Income tax relief – Landlords have been able to off-set mortgage interest and buy-to-let mortgage arrangement fees against their income tax bills at up to 45% for higher earners.
However, this tax relief is being reduced and will be capped at 20%. The new measure is being phased in over three years from 2017.
Wealthier, higher tax paying landlords will therefore be the most affected. Experts warn that landlords could be up to £2000 per year worse off, based on typical rents. Cash buyers and investors in 20% tax band least affected.
Unless you are a cash buyer, you will need a buy-to-let mortgage as a standard residential mortgage only applies if you plan to live in the property. A buy-to-let mortgage will enable you to rent out your property to tenants – this is not permitted with a conventional mortgage.
The amount you can borrow is based on how much rent the property can generate versus the cost of the mortgage. Typically, lenders will want your expected rental income to meet at least 125% of the monthly interest payments on the loan.
Buy-to-let lenders may also require you to have a minimum salary, typically £20,000-£25,0000.
Buy-to-let mortgage interest rates are higher than standard mortgages due to the greater risk involved.
The minimum deposit is generally 25% of the purchase price and the cheapest deals require a deposit of 40% or more.
Arrangement fees can be higher than on a conventional mortgage. These are sometimes calculated as a percentage of the amount you borrow, rather than a flat fee.
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To assess if buy-to-let is financially viable, you need to know a property’s yield. This is the rental return a property generates. Average yields in the UK are roughly 5%.
In its simplest form, this is calculated by dividing the annual rental income by the purchase price, then multiplying by a 100, to give the gross rental yield as a percentage.
For example, annual rent of £7200 divided by purchase price, £145,000 multiplied by 100 gives a gross yield of 4.9%. If you don’t know what the rental income will be, ask the estate agent who is advertising the property.
If you’re taking out a buy-to-let mortgage to purchase a property the lender will want to know you can secure enough rent to make the repayments. Under strict new rules imposed by the Prudential Regulation Authority many lenders have increased their rental requirements in order to reduce risk. This means landlords must be able to achieve higher rents in order to secure the mortgage. However, some lenders will allow a landlord to use their own disposable income to meet any rental income shortfall so it’s important to shop around.
Choosing the right buy-to-let property
The property adage, location, location, location, is doubly important with buy-to-let.
Most people travel to work and the best buy-to-let investments are generally those within a fifteen minute walk of a train or tube station.
Find a property to suit local demand. A funky flat above a brasserie might suit commuting professionals but not a young family.
Resale property is generally bigger and cheaper to buy than new build.
Be wary of buying into a block of flats with many other buy to let investors. Too many flats to let at the same time, means rents could fall or worse still, voids. It can also make selling harder.
Being a landlord comes with a wide range of legal responsibilities which include:
Contract – You must provide your tenant with a contract, generally an AST (Assured Shorthold Tenancy). This gives tenants the legal right to live in the property for a fixed period or a rolling term.
Right To Rent – All landlords are now responsible for checking their tenants have the right to rent in the UK. Give every tenant a copy of the Government’s How to Rent booklet.
Tenancy Deposit Protection – Protect your tenant’s deposit in government backed schemes such as DPS (Deposit Protection Service), TDS (Tenancy Deposit Scheme) or mydeposits. Give your tenant details of where their deposit is protected.
Gas and Electrics – Check gas appliances once a year using a gas safe registered tradesman and give tenants a copy of the safety certificate.Wiring and electrical appliances also need to be checked regularly.
Energy Performance Certificate – Your property must have an up to date EPC before it can be marketed and you must give a copy to your tenant. An EPC is valid for ten years. Get quotes for an EPC here
Fire – Furniture and soft furnishings must pass fire safety regulations. Check for fire retardant labels. Fire alarms have to be fitted. Fit a carbon monoxide alarm in any room with gas appliances.
Many landlords manage their own properties. It can be helpful to join a representative organisation such as The National Landlord’s Association or The Residential Landlord’s Association. Get to know good plumbers and builders to help you manage your property smoothly. See our Find a Tradesman service here