Mortgages for landlords have been a huge growth area in recent years. According to figures from the Council of Mortgage Lenders, at the end of 2006 there were 840,000 buy-to-let mortgages outstanding with a total balance of £93.2bn. A decade later, this number had more than doubled to 1.8m mortgages with an aggregate balance of £214bn.
But what is a buy-to-let mortgage? How much can you borrow? And where do you get one? Keep reading for our guide to everything you need to know.
How does a buy-to-let mortgage work?
In principle, buy-to-let mortgages work in the same way as a residential mortgage: a lender advances you a sum of money over a fixed period, secured against a property.
You make your monthly mortgage payments as agreed, and you get a choice of fixed, variable and tracker rate deals as you would with a residential mortgage.
However, there are some key differences between residential and buy-to-let mortgages:
- Buy-to-let mortgages are often on an 'interest only' basis whilst most new residential mortgages are arranged on a repayment basis
- The amount you can borrow is typically determined by the rental income the property will generate, not by your own earnings
- You will generally need to put down a larger deposit.
Keep reading for information on all these areas.
What deposit do I need?
Buy-to-let lending is generally considered riskier than residential lending. So, you will normally have to put down a larger deposit.
Most lenders require a deposit of at least 20-25% of the purchase price, while some will require even more than this. As with most mortgages, you'll generally benefit from a lower interest rate if you put down a larger deposit.
On a property valued at £150,000 you would generally need a deposit of at least £37,500.
Many people use equity in other properties to fund the deposit for a buy-to-let purchase. Find out how you can use equity in another property to purchase a buy-to-let investment.
How much can I borrow?
When you take out a residential mortgage, the lender determines how much you can borrow based on your income and outgoings.
With a buy-to-let mortgage, the amount you can borrow is generally worked out based on the anticipated rental income of the property. Lenders will generally need the rental income to be 125% of your 'interest only' mortgage payment although some lenders need the rental income to be 140-145% of your mortgage payment.
Here's an example. You want to borrow £120,000 on a property worth £160,000. The interest rate is 3%, meaning that your monthly interest only mortgage payment is £300. A lender would normally need the rental income of the property to be 125% of this amount, namely £375.
While the amount you can borrow is normally based on the rental income, some lenders have a minimum personal income requirement. You may have to prove that your income is more than £20,000 or £25,000 in order to qualify for a loan.
Remember that you will have to meet your mortgage payments whether or not you have tenants. If you have a void period (a period between tenants when the property is empty) you will have to pay the mortgage from your own income.
Interest-only mortgages
Most buy-to-let mortgages are arranged on an interest-only basis. This is because landlords are generally looking to minimise their outgoings and to create as much cash flow as possible. There can also be tax advantages of arranging the mortgage in this way.
Most landlords expect to repay the mortgage from the proceeds of the sale of the property.
Where do you get a buy-to-let mortgage?
Many High Street banks, building societies and specialist lenders offer buy-to-let mortgages. However, finding the right buy-to-let deal for you can be difficult as lenders have different criteria. Factors you may have to take into account include:
- The type of property – some lenders won't lend on new-build properties, particularly flats or apartments in built-up areas. Other lenders won't consider properties designed for multiple occupation.
- The type of tenant – some lenders won't consider a buy-to-let mortgage if you're planning to let the property out to certain groups, for example students or tenants in receipt of benefits.
- The type of tenancy – most lenders want the property to be let on an assured shorthold tenancy. Other types of tenancy may cause problems.
- The number of buy-to-let mortgages you have – lenders often have a limit on the number of buy-to-let mortgages that you have. They may also restrict the number of mortgages you can have with that particular lender.
Speaking to an independent mortgage broker can help as many buy-to-let products are only available through intermediaries. With access to a wide range of buy-to-let mortgage products, a broker can find the right product, right lender, and right type of mortgage for your needs.
Use our mortgage calculator to find out how much your buy-to-let mortgage will cost.
Fees and costs mean a buy-to-let should be a long term investment
Buy-to-let properties should be seen as a long-term investment. House prices are volatile, and while you will generally see an increase over the long term, there could be falls in the value of the property in the short-term.
The costs of taking out a buy-to-let mortgage are also generally higher than a residential mortgage, meaning you may need to keep the property for longer to recoup your investment.
You'll typically have to pay for a valuation fee and an arrangement fee for your buy-to-let mortgage. Arrangement fees for buy-to-let mortgages are frequently more expensive, and it's not unusual for you to pay a percentage of the mortgage amount (1-3%) as a fee.
Lenders will allow you to add the fee to your mortgage, but this means you'll then pay interest on the fee for the lifetime of the loan.
If you're using a mortgage broker then you may have to pay a fee for their services. You will also have your conveyancing and Stamp Duty costs (if applicable).
For more buy-to-let mortgage advice and to get free advice, head here.