Buy to Let
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If you’re planning on purchasing a property to rent out, and you aren’t purchasing it with cash, you’ll need to have a ‘buy to let’ mortgage.
As you might expect, they differ in some respects to conventional mortgages you’d take out if you were buying a residential property.
Differences between standard and buy to let mortgages
One of the biggest differences between the two mortgage types is that buy to let mortgages are offered on an interest-only basis. What that means is your monthly payments will cover the cost of the interest on the mortgage. But, the money you’ve borrowed to buy the property, the capital debt, will not get paid off.
At the end of the mortgage term, you are required to pay off the capital debt in full. One way to do that is by selling the property. Alternatively, some people may simply take out another mortgage and keep the property.
Another significant difference with buy to let mortgages is that you’ll typically need a larger deposit and pay higher rates of interest than residential mortgages. Also, you’ll need to pay a larger amount of stamp duty on the property as it’s not your main home.
The majority of buy to let mortgages aren’t regulated by the FCA (Financial Conduct Authority). There are some exceptions, though, such as if you’re renting your property out to a relative or partner. In those cases, they are referred to as consumer buy to let mortgages and applications get assessed the same as for standard mortgages.
Who can get a buy to let mortgage?
If the following applies to you, then it’s possible for you to find a buy to let mortgage:
- You are looking to invest in property such as houses or flats;
- You understand the risks involved with investing in property;
- You’re an existing homeowner, with or without a mortgage;
- Your credit record is good, with no defaults, CCJs, bankruptcies;
- You earn at least £25,000 per year, and aren’t living above your means;
- You will be 70 to 75 years old or younger by the time the mortgage finishes
Why are buy to let mortgages pricier than standard ones?
A buy to let mortgage tends to cost more to set up and pay each month than a standard mortgage. The reason for the increased costs is due to the higher interest rates and fees charged by mortgage lenders. Buy to let mortgages represent a higher risk to lenders because landlords might not have the rent paid to them on time (or at all) to cover the mortgage payments.
A positive thing to bear in mind with buy to let mortgage payments is they are usually cheaper than standard mortgage ones. That’s because you are only paying the interest on the loan, rather than the interest and capital at the same time.
How much can you borrow for a buy to let mortgage?
The thing about buy to let mortgages is that the amount you can borrow isn’t solely down to how much you earn each year. Instead, the figure is based on the rental income you hope to achieve, calculated at a stress rate of typically 5.5% and based on your personal tax threshold.
How much deposit is needed for a buy to let mortgage?
Buy to let mortgage lenders will usually ask you for a large deposit, such as 25% of the property’s value. In some cases, this could even be as high as 40% depending on the type of property. The reason lenders ask for such a high deposit is simply to protect themselves in case you default on your mortgage repayments.
Believe it or not, there are some benefits to putting down a large deposit on a property. For a start, a larger deposit means there is a lower amount to finance on your investment.
You will have less to pay off or refinance at the end of the mortgage term and you may also be eligible for a lower interest rate due to a lower loan to value (LTV).
The mortgage repayments could be significantly lower each month. This means the difference between your rental income and what your mortgage payments are could help you achieve a healthy profit each month.
What happens if there is no rental income?
As you might expect, there will be times where you won’t have any rental income to cover your mortgage repayments. Examples might include when one tenant moves out and you’re waiting for a new one to move in. Or, in some cases, tenants don’t pay for whatever reason and fall into arrears.
It makes perfect sense to come up with a contingency plan to cover such events. In an ideal world, there wouldn’t be any interruption in rental income from your investment property. But, the reality is often much different from what we’d like to happen.
So, with the above in mind, how can you plan for a lack of rental income? One option is, of course, to save up some money to cover your mortgage repayments for a certain period. Doing so is a good idea for when your property might be vacant and you’re waiting for new tenants to move in.
When it comes to non-paying tenants, you could also use that savings fund to cover the shortfall. Assuming the tenants bring their balance with you up-to-date, you can then top up your savings fund with that money. Another option is to take out an insurance product that will cover such issues. These days, many leading property insurance firms offer rental income protection for landlords.
There are some ways that you can lessen the likelihood of your property not yielding a rental income:
- Do a credit check on your prospective tenants. If you’re not using an estate agent to manage your lettings, you should credit-check any tenants looking to rent your property. That should give you a clearer picture of their financial situation, and the likelihood of them defaulting on any rental payments;
- Get new tenants to move in when an existing tenancy is due to expire. Of course, you won’t need to worry about that if your existing tenants are happy to renew their tenancy agreement with you;
- Ask tenants to provide a creditworthy guarantor. It’s not something that happens often, but it’s a way of ensuring the rent will get paid no matter what happens.
Is there any tax to pay on buy to let properties?
In a word, yes. Because you are renting out your property to make a profitable income from it, you will need to pay some taxes on that income. The taxes you’ll usually have to pay are Capital Gains Tax and Income Tax. They are explained as follows:
Capital Gains Tax
For basic rate taxpayers, the capital gains tax is charged at a rate of 18%. If you’re a higher or additional rate taxpayer, that goes up to 28%. If you’ve got other assets as well, your basic rate of capital gains tax is 10%, or 20% for higher tax brackets.
Should you decide to sell your property to make a profit, you’ll need to pay capital gains tax if your profit is more than the annual threshold. As of the 2019/2020 tax year, that threshold is £12,000. If you’re selling a property jointly bought with your spouse or partner, you could combine your allowances to double the allowance.
It’s also possible to reduce capital gains tax charges by taking into account things like property purchase fees. Or even losses made from another buy to let property in a previous tax year.
Last, but not least, the income you make from your buy to let property must be declared on your tax return each year. If you exceed your annual allowance, you could reduce your income tax liability in a few ways. For example, you could deduct fees like council tax or property maintenance costs.
It’s also possible to get mortgage income tax relief as well, which can go some way to reducing your income tax liability. And, of course, it will increase your profitability.