What is a buy-to-let mortgage? We explain how buy to let mortgages work in simple terms
Buy To Let mortgages are an excellent way for property investors to make money.
This comprehensive guide for buy-to-let mortgages will explain how they work, what criteria you need to meet, and the pros and cons of becoming a landlord.
Our FAQ section answers the most common questions about BTL mortgages.
What is a buy-to-let mortgage? How do they work?
A buy-to-let mortgage allows you to purchase a property and rent it out to tenants. Buy-to-let mortgages are available in the UK for interest only. The landlord pays the monthly interest with rental income.
There are many types of buy-to-let properties, including apartments and houses. It is against the lender’s rules to rent your property without a BTL mortgage unless you own it.
What they are different from residential mortgages
The main difference between a residential mortgage and a buy-to-let is determining affordability. BTL is all about the investment’s strength. Lenders calculate this based on rental potential. The expected rental income must be sufficient to pay the mortgage payments. This is calculated at both current and future interest rates.
The customer’s income determines the affordability of a residential mortgage. Although some BTL lenders may consider personal income in their affordability calculations, the most crucial factor is the potential rental income. Buy-to-let mortgages can have higher interest rates and deposit obligations.
Unlike its residential counterparts, the Financial Conduct Authority (FCA) does not regulate most buy-to-let mortgages.
Repayment mortgages for buy-to-let
Most landlords opt for interest-only buy-to-let mortgages to reduce overheads and maximise tax efficiency. However, selecting a capital repayment mortgage can reduce your monthly debt. You’ll pay more monthly, allowing you to build equity and eventually own the property.
For more information on these products and how they compare with interest-only BTL mortgages, please visit our guide to purchasing to let repayment mortgages.
Landlords should be aware of restrictions.
Without permission from the lender, landlords can’t live in buy-to-let homes. This would also mean that they could switch to another product type. In 2021, landlords can no longer deduct mortgage expenses from rental income. They are entitled to a 20% tax credit for interest payments.
You should also be aware of recent changes in buy-to-let regulations.
- In the summer of 2020, new electrical safety standards were introduced for landlords. These standards can be viewed in detail on the UK Government website.
- Last year, a new code of practice was introduced to assist landlords with their rent problems.
- New reforms allow leaseholders to extend their lease for up to 990 years.
- As part of the government’s support for renters during the coronavirus epidemic, tenants are expelled until March 2021. Unless you use a specialist broker, you only have access to a third of the Buy To Let available mortgages.
What is the maximum amount I can borrow?
The sky is the limit as long as you prove that your mortgage debt can be serviced from the rental income you will earn each month. BTL mortgage lenders won’t approve loans if the expected rental income exceeds the mortgage payment by a certain percentage. This is usually 25-30%.
Although buy-to-let mortgage lenders don’t have a maximum loan limit, affordability assessments can still be stringent. You won’t pass an affordability assessment if you don’t have a forecast of your rental income from an ARLA-regulated agent.
Some lenders require a minimum income to approve you for a buy-to-let mortgage. This applies regardless of whether you will likely have a self-funded investment property. A typical number is around £25,000 in proven earnings.
Is it worth buying a mortgage to buy-to-let?
You can decide if a buy-to-let mortgage is right for your investment by understanding the possible advantages and disadvantages. The benefits and drawbacks of a buy-to-let mortgage are listed below. A mortgage broker can discuss them in greater detail with you.
Advantages
These are the benefits of a buy-to-let mortgage:
- Long-term investment returns: While a buy-to-let property may bring in rental income and short-term profits, rental property has the potential to prove to be an excellent long-term investment. You might make money by selling the property or remortgaging later.
- Rental solid market: Although the UK Government has pledged to “turn Generation Rent into Generation Buy”, the demand for quality rental accommodation is still high. Many landlords are taking advantage of this, particularly in certain UK hotspots.
- Tax benefits: You can claim some of the running expenses associated with buy-to-let properties by submitting your Self-Assessment tax return to HMRC each year. These costs include interest on mortgage repayments, allowing agent fees and repair costs.
Potential disadvantages
These potential disadvantages are not necessarily applicable to everyone. A broker may be able to help you avoid them.
These include…
- Tenant-related risk: There are always risks for tenants. These include the possibility of renters becoming arrears, causing property damage, or renting out their properties. To protect themselves from these risks, many landlords choose comprehensive insurance policies.
- Stamp duty higher: Buy-to-let properties are subject to a higher stamp duty rate. Buyers will have to pay an additional 3% stamp duty compared to residential property purchases. If you are considering other investments, this should be taken into account.
- Long-term market uncertainty
Criteria for eligibility
To determine whether a BTL mortgage application is acceptable, buy-to-let lenders use the eligibility criteria.
Minimum deposit requirements
A typical loan-to-value (LTV) ratio for buy-to-let mortgages is 75-80%. Most BTL lenders will require you to deposit 20-25% of the property’s value as a down payment. However, fewer providers will approve customers with deposits as low as 15% if the circumstances are right.
The interest rate you can get will depend on how much deposit you have available. Lenders taking greater risk due to bad credit may require a higher deposit.
If you have enough equity in your property, it might be possible to let some of it go and use it as a deposit on your buy-to-let loan.
Income
We mentioned in the affordability section that most buy-to-let mortgage lenders base affordability upon the projected rental income. However, some lenders have lower income requirements. BTL mortgage lenders impose this restriction. They won’t lend to people with less than £25,000 in other income sources.
However, there are buy-to-let mortgage lenders who will lend to people with no income. These agreements are based entirely on rental income. You can apply to one of these lenders by contacting a mortgage broker familiar with the market.
How to prove your income
By arranging a report from an ARLA registered agent, you will be required to give your buy-to-let mortgage lender a rental income projection. Search online for an agent in your area on the ARLA website.
BTL mortgage lenders may also require proof of income. They will typically request three months of bank statements to prove your earnings. Most lenders will require two years’ worth of tax returns and copies/copies of lease agreements from landlords looking to increase their property portfolio.
What happens if I don’t have proof of income?
You will then need to find a buy/to-let mortgage lender that does not require you to have a minimum income. These lenders are flexible and often base the agreement on the property’s expected rental income.
You must request a letting agent’s report to prove the rental potential. Suppose the lender’s affordability requirements are met. In that case, it may be possible for you to obtain a buy-to-let mortgage based on this report alone as long as your eligibility criteria are met.
The caveat is that it can be difficult for you to find buy-to-let lenders without income requirements if your search is done alone. If you want to purchase an investment property without any income, a mortgage broker with the extensive market knowledge and relationships with niche lenders is highly recommended.
Credit history
Although it is possible to obtain a mortgage buy-to-let with certain types of bad credit, you may not be able to access lenders or get the available products.
The credit score of your credit history, as well as whether or not you are eligible for loans, will determine whether you are approved. You might be required to make an additional deposit to offset the risk. Customers with good credit are more likely to be eligible for lower rates.
Additional rules and requirements
- Your age: If you are under 21 or 75, the number of lenders and products you can apply for will be less. However, there are buy-to-let mortgage lenders that specialise in older customers and will lend to borrowers over 75.
- Property type If the property you buy is a standard home, your mortgage application may be simple. This could be a house, flat, or apartment that is brick-and-mortar. Any other type of construction might require a lender experienced in unusual buildings and non-standard construction.
- Landlord Experience: Some Buy-to-Let Mortgage Lenders prefer customers who have landlord experience. This will show them that you are capable of executing your plans. However, fewer BTL lenders specialise in first-time landlords.
BTL Mortgage lenders will not lend to people who don’t own a residential mortgage. Many will require you to be a homeowner for six months. However, some may accept less. A few mortgage lenders offer buy-to-let mortgages for first-time homeowners.
Costs of a typical buy-to-let loan
Broker fees
The complexity of your buy-to-let mortgage and the product you choose will determine the amount you pay. For arranging your mortgage, some brokers charge £0 while others charge up to 4%.
Lender application/ booking fees
Every lender deal is different. While some deals are free, others have non-refundable upfront costs, such as £500. They can only accept applications from borrowers who are more serious about proceeding. Fees for a buy-to-let mortgage are generally higher than for residential.
Valuation fees
It all depends on the property’s type, value and location. Some mortgage products provide a basic valuation report for free. Homebuyers and complete structural surveys are usually more expensive.
Fees for mortgage products
They depend on the product type and property value. A few lenders will not charge fees, while others may charge a fixed fee of around £500 or a percentage of your loan amount. It might be more cost-effective to select a product with no fees or fixed fees for larger buy-to-let mortgages.
Exit fees for mortgages
These can vary from one lender to another and from product to product. You may also be subject to additional fees if your buy-to-let mortgage is tied and you want to cancel early. These are known as Early Repayment Fees (ERCs).
Legal costs
Solicitor fees & disbursements
Prices for solicitors vary depending on the charging structure. Fixed fees are common; others charge per hour and a percentage of the property. This is rarer these days. Lenders may offer legal assistance for buy-to-let buyers to encourage them to get their BTL mortgage deal.
Stamp duty
Buy-to-let landlords may be liable for the surcharge, ranging from 3% to 15%. See the UK Government website for exact stamp duty rates today.
Permanent costs
Property maintenance
The cost can range from nothing to a substantial amount. It all depends on the condition of your property and ongoing repairs.
Fees for a letting agent
There are two options: a flat fee or a percentage of your rental income. Standard charges include 10% of the monthly rent or a charge of £35pm for a rental of £350pm.
Income tax
You are starting at £0-50%. This depends on your income and tax rate. HMRC has more information on buy-to-let taxes.
Landlord insurance
The cost of landlord insurance can vary depending on where you live, how big it is, what type of tenants you have, and what kind of policy you choose.
The most common policies landlords may need are contents insurance, rental protection insurance and public liability insurance. They also have legal expense coverage, tenant malice, portfolio, and general liability insurance.
Rent returns and yields
The rental return is the difference between your rental income and monthly mortgage interest payments. It can be expressed as a percentage. If your monthly mortgage interest payments total £1,000 and your rental income totals £1,100, your rental return on your buy-to-let property would be 110%.
Lenders want to see a projected rental income of at least 125% before offering a BTL mortgage. They will conduct a stress test to determine if a property meets these requirements. It involves comparing your rental income forecast with the mortgage rate that you are eligible for.
The rental yields are, in turn, the amount of cash that your property generates. They are calculated as a percentage of their value and broken down into gross and net values. Divide the purchase price of your property by the rental income it generates each year to calculate your rental yield.
Suppose the purchase price is £100,000. The rent per week is £200. Your buy-to-let property yield will be 10.4%.
Experts will advise you to search for properties with at least an 8% rental yield.
What documents do I need to submit my application?
To obtain a mortgage to buy-to-let, you will need the following documents:
- Evidence of income (usually the three most recent payslips)
- Statement of mortgage for an existing property
- A report from an ARLA-regulated agent is generally sufficient to prove rental income.
- You will need proof of deposit (if you have a donor, you’ll also need this in writing).
- If applicable, evidence of any bonus or commission
- Photo ID (passport/driving licence)
- Address proof
- Current or most recent P60
- If you are self-employed, your SA302 tax returns forms
How to apply for a mortgage buy-to-let
In three simple steps, you can start a buy-to-let mortgage application.
- Get a projection of the rental income for your property. This can usually be done by requesting a report from an ARLA registered to let agent. It can be helpful if you can prove your personal income.
- Review your credit reports. Before you apply, download all your credit reports. This is vital because it will allow you to challenge any errors and make sure your credit reports are up-to-date. You can also find out what your mortgage lender or underwriter will see when they review your credit history.
- Talk to a mortgage broker. Although it is not necessary, this is highly recommended. A mortgage broker specialising in buy-to-let will help you find the best deal, provide bespoke advice, and take care of all your paperwork. This could potentially save you money down the line.
Your initial consultation with the buy-to-let broker is free, and you are not required to continue. However, they will help you navigate the application process if you decide to go ahead. They will also make sure that you find the right lender.
Your broker may suggest you apply for a buy-to-let mortgage in principle. This agreement is the initial one you make with your lender. It will determine how much money you can borrow and what terms and conditions. Before you can proceed with a complete application, additional credit checks and underwriting will be required.
Some mortgage lenders skip the AIP stage and go straight to complete the application.
Talk to a specialist mortgage broker for buy-to-let
Are you looking for information or advice about buy-to-let loans? A broker specialising in rental property financing can answer your questions and help you achieve your goals.
There are many different buy-to-let brokers. There are many areas of expertise in this area of mortgage lending. You need to talk to the right specialist to find the best deal for you.
FAQs
Why is buy-to-let mortgage lending unregulated?
Because lenders in this industry need greater flexibility to offer mortgages based on rental income, most buy-to-let mortgages do not have to be regulated by FCA. Markets are not free from shady deals or underhand practices, even though they lack FCA regulation. Lenders must adhere to their codes of ethics.
There are also regulated buy-to-let mortgages. These mortgages are typically offered to landlords who rent to close relatives or property owners who have inherited a buy-to-let property.
These are called consumer mortgages. You can find out more about them in the separate guide at the link.
What are the benefits of a buy-to-let mortgage when you rent?
Your mortgage terms and conditions will most likely prohibit you from renting out a property you don’t own. If you are caught, your mortgage lender may request that you pay the entire loan amount in one payment. This could result in you having black marks on credit, which can impact your ability to apply for financing.
You could face prosecution for mortgage fraud in the worst possible scenario.
It is important to tell your lender that you are planning to rent your home. This could mean you have to switch to another type of mortgage to make it legal. You could commit mortgage fraud if you fail to inform your lender.
Which type of property is best to rent?
There is no single answer as there are many factors that you need to take into consideration, including the property’s location and investment preferences. If you are a long-term investor, experts will advise you to consider the property’s rental yield and capital gains.
Zoopla published data about property types and capital gains to show how each type appreciates over five and twenty years…
Property type detached House
After five years:31.84%
After 20 years:245.49%
Property type Semi-Detached House.
After 5 years:33.60%
269.59% after 20 years
Property type Terraced House
After five years:32.16%
281.87% after 20 years
Property type Flat/Apartment.
After five years:28.76%
256.42% after 20 years
How can I purchase my first property to buy-to-let?
Most experts recommend waiting to apply for a buy-to-let mortgage to purchase your first investment property. This will allow you to have access to a larger pool of lenders.
You don’t have to own any property before getting a BTL mortgage. However, it is possible to obtain one.
A BTL mortgage may not be an option for people with other properties. It may be possible for you to remortgage if you have been paying your residential mortgage for some time to free up equity that can be used to purchase your first buy-to-let.
Alternatively, you may be able to switch from a residential mortgage to a buy-to-let mortgage, if you wish to rent out your residential property.
This is a difficult question without considering your unique circumstances and needs. This is not something you will find an easy answer to online. You should not make significant financial or investment decisions after a Google search. These decisions should only be made after seeking professional advice from the right expert.
We can connect you with a specialist in buy-to-let who will go over all your options for property investment.
Why does a landlord use an interest-only mortgage?
Most landlords view buy-to-let as long-term investments. The rent they charge tenants can pay the interest and still make a profit. If they have an interest-only mortgage, their overheads are lower because there are no capital repayments.
What if my income is less than £25k, and I want to buy-to-let?
Yes. Yes. Although £25,000 is the minimum income requirement for buy-to-let mortgage lenders, some might approve your mortgage application even if you make £20,000. Depending on their projected rental income, BTL mortgage providers will also lend to people with no income.
What tax do I have to pay if I sell my buy-to-let property?
Yes. Landlords must usually pay Capital Gains Tax when selling a buy-to-let property. If you sell your property at a higher price than what you paid and with lower stamp duty and agent fees, you will have to pay Capital Gains Tax (CGT). The CGT rate for the property is 18% for basic-rate taxpayers in 2020/21. The rate for higher- and additional rate taxpayers is 28%.
What happens if I am caught living in my buy-to-let?
You would violate your BTL mortgage terms. Your lender may demand payment in full. You could default, and your future credit rating and ability to apply for finance may be damaged.
Do I have to own a house to get a mortgage for a buy-to-let?
Some buy-to-let lenders will lend mortgages to first-time homeowners, but this is not a requirement. However, most mortgage lenders prefer customers who have owned the residential property for a minimum of six months.
A mortgage broker with extensive market knowledge is recommended to help you find a lender that will consider a buy-to-let mortgage for a first-time buyer.
What stamp duty will I have to pay for buy-to-let?
Below is information about the current stamp duty rates for buy-to-let properties in England or Northern Ireland. These rates are effective until March 2021.
- Property price: £0-£500,000
- Stamp Duty Rate3%
- Property price: £500-£925,000
- Stamp Duty Rate8%
- Property price: £925-001-£1.5m
- Stamp Duty Rate13%
- Property price: Over £1.5m
- Stamp Duty Rate15%
You can find out more about stamp duty on HMRC’s website.