Buy-to-let Mortgages: What you Need to Know

1. What is a buy-to-let mortgage?

When you buy a property as an investment, you will not be able to fund your purchase with a normal residential mortgage. Instead, you will need a specialist buy-to-let mortgage. There are two main differences between a buy-to-let mortgage and a residential mortgage that must be considered.

Firstly, lenders see buy-to-let mortgages as higher risk because many buyers will use the rent to make their repayments. Should a landlord have issues with rent collections or suffer from periods of inoccupancy, lenders see a risk that they will default on repayments. This is not true for most landlords, who are generally financially secure people not solely dependent on rental income.

Nevertheless, because of the higher risk involved you will be required to pay a larger deposit. This is generally at least 25% of the total value of the property but depends on the lender in question. There are some lenders that might offer buy-to-let mortgages that only require a 20% deposit but expect to pay higher mortgage rates. To benefit from the best mortgage rates on the market some lenders might require a deposit as high as 40%. The table below highlights that most buy-to-let mortgages deals require at least 25% deposit.

Different LTV products currently on the market

To put this into context, if you were to buy a £240,000 two-bedroom property with a 25% deposit, you would be required to pay £60,000 up front. If you wanted the better rates and decided to use a 60% Loan-to-Value (LTV) mortgage with a 40% deposit, you would pay £96,000.

Secondly, buy-to-let mortgages are mostly interest-only, whereas residential mortgages are primarily capital and interest loans. An interest-only mortgage requires the buyer to pay back monthly interest payments on the loan rather than the actual loan itself. Interest only repayments are much lower than capital and interest repayments, which allows for better landlord cashflow.

At the end of the term the mortgage must be repaid in its entirety. Most property investors will look to sell their property for more than they bought for, pay back the loan and take some profit. However, if the property’s value has fallen over this period, then you will need to find the difference from somewhere. Therefore, it is crucial that you are buying a secure and profitable investment in an area with good yields but also strong capital appreciation. This way you will not be stung down the line.

2. Can I get a buy-to-let mortgage?

Now you understand the two main differences of a buy-to-let mortgage you might be wondering whether you would be accepted for one. Acceptance of a buy-to-let mortgage is remarkably similar to a residential mortgage and depends on a variety of circumstances, including:

You are wishing to purchase the property

Familiar with the risks involved with investing in property and can afford to take them on

Have a good credit record and do not have excessive amounts of debt, for instance on credit cards

You earn more than £25,000 a year. Lenders will be unlikely to approve a buy-to-let mortgage if you earn less than this

You are not over 70/75 years old. Lenders usually have an upper threshold of 70 to 75 and will usually not lend to people older than this

Affordability: Interest Cover Ratio’s

The above conditions are quite standard across all mortgage types. However, you should expect to be subject to a much more stringent affordability test when getting a buy-to-let mortgage. As part of the affordability assessments, lenders will use what are known as Interest Cover Ratios (ICR’s).

These are used to calculate how much profit a landlord is expected to make in relation to the monthly interest payments. In other words, the ratio of money the landlord will make in rent after making interest repayments. Banks usually use a representative value of 5.5% to determine the ICR.

Most lenders require that the projected rental income of the property be at least 125% of the landlord’s mortgage payments. In some cases, this is much higher. You must therefore make sure the rent that is achievable for the property is at least 25% more than the interest repayments.

4. What mortgage rates should I expect?

Now we have a firm grasp of the different types of mortgage products available and the inherent advantages and disadvantages of each. You might be interested in what interest rates you should expect when choosing a mortgage product. Ultimately, you will need to shop around for the best rates, and we would always advise using a mortgage broker. The cost of using one will invariably save you money in the long term.

Nevertheless, we can have a look at the average fixed rate mortgages in the UK over the last 6 years. As you can see, In Q4 2020 during the Coronavirus pandemic, the average fixed-rate buy-to-let mortgage had an interest rate of 3.1%. This is down from 3.99% five years earlier, as shown in the graph below.

Source: Moneyfacts

At the time of writing, interest rates are at record lows which is excellent news for landlords. Lower interest rates equals more money in your pocket each month. However, despite the low interest rates lenders have become increasingly cautious about who they lend to and what they lend on. When purchasing a buy to let do not be alarmed if some lenders will not lend on your property, you might need to shop around to find the right one.

6. What happens at the end of my buy-to-let mortgage?

Should you choose to sell your buy-to-let property or remortgage it you will be required to pay off the loan. If you are on an interest only mortgage, which is commonplace for buy-to-let properties, you will have no equity in the property. This is because over the period of owning the property you will have only paid the interest and not the actual loan.

In this situation you will expect the property value to have increased and you can therefore pay off the loan and take the capital appreciation for yourself. Traditionally, in the UK, property prices have doubled every 10-20 years. It is therefore safe to assume that over a longer period the property will go up in value. However, there are times like during the 2008 financial crash that property prices take a huge hit. If you were to sell the property during these downswings, then you might struggle to pay the loan back.

It is for this reason you should always invest in property sensibly. At CityRise we are here to offer you the best property investment advise and opportunities on the market. Please get in touch if you want to learn more about how property can work for you.