An introduction to buy-to-let mortgages

Matt Stevens, managing director of mortgage broker The Mortgage Genie, discusses why many first-time investors are looking at buy-to-let and explains the basics of these kind of mortgages.

Property has always been a popular form of investment among Brits. Not only can you generate monthly income in the form of rent, there is also a chance that the value of your property will increase over time.

With buy-to-let mortgage rates at an all-time low, many are now looking to this form of investment as a way to make money for many years to come. In this guide, I will tell run through the basics of buy-to-let mortgages to help give you an idea of whether it is the right investment for you.

What is a buy-to-let mortgage?
If you want to become a landlord but can’t afford to purchase your investment property outright, you’ll have to apply for a buy-to-let mortgage. They work in much the same way as a residential mortgage: you will receive a loan to cover the purchase price of the property, that loan will be secured against the property itself, and you will have to pay that money back over a pre-agreed period of time. However, there are some key differences that you must take into consideration.

How are buy-to let mortgages different to regular mortgages?
First of all, interest rates tend to be higher on buy-to-let mortgages and arrangement fees are more expensive. Most landlords opt for an interest-only mortgage, paying off their interest each month but not paying off the value of the loan (the capital) back until the end of the loan period. This is because many landlords plan to sell up and move on long before their agreed loan period, paying the bank back in full and pocketing any profit from house price inflation.

Rather than looking solely at your personal income to determine affordability, your lender will also assess the potential rental income of the property. Lenders will generally want to see that the property will be able to generate rental income of at least 125% of the monthly mortgage repayment. The size of the deposit required for a buy-to-let mortgage is also much higher than its residential counterpart.

Am I eligible for a buy-to-let?
As buy-to-let mortgages are a bigger risk for lenders, the criteria that you must meet are much stricter than a standard mortgage. Lenders will still take into account your income, how much you spend, how old you are, and how much of a deposit you have, but they will also assess the potential rental income of the property you wish to purchase.
Income: As with a standard mortgage, lenders will assess your income to make sure you can afford the mortgage. Even though rental income will more than cover the cost of the mortgage, lenders generally require a minimum income of £25,000 to act as a cushion should the property remain empty for long periods of time or if the tenants are not able to pay rent.
Age: Lenders also place age limits on those they will grant buy-to-let mortgages to. Typically, if you are over 75 or under 25 it will be hard to get a buy-to-let mortgage, as lenders see these two age groups as riskier propositions. As with all of these guidelines, some lender make exceptions to certain rules and you should speak to a mortgage advisor to discuss your personal situation.
Deposit: As buy-to-let mortgages are riskier than residential mortgages, you will be required to put down a larger deposit. While it is possible to get a residential mortgage with 0% down, a buy-to-let mortgage will require at least 25%, with the best rates being unlocked at 40%.
Rental income: To check the affordability of a buy-to-let mortgage, lenders will make a rent-to-interest (RTI) calculation, which allows them to work out the ratio between your rental income and the monthly payments owed on the mortgage. The monthly rental income must generally be at least 125% of your monthly payment, sometimes rising to as much as 150%.

Buy-to-let mortgage interest tax relief
In the past, buy-to-let has been encouraged by a form of tax relief that allowed landlords to only declare their rental profit for tax purposes — that is, the difference between their rental income and their mortgage repayment. This cut the tax bill for landlords by hundreds if not thousands of pounds, but this form of relief is now coming to an end. From 2020, all rental income earned will be taxable, but landlords will receive a 20% tax credit on their interest, cutting their interest repayments by 20%.

So that is buy-to-let mortgages in a nutshell, hopefully you now have a better understanding of this kind of investment. Remember, as with all investments, you should think carefully before making any decisions.