Buy to let home loans – What are the various options?
In 1993 the Association of Residential Letting Agents invented the term ‘buy to let mortgage’. Before then potential landlords and investors in residential letting properties took out commercial mortgages to buy properties which they intended to rent out.
Buy to let lending became very popular in the late 1990s and early 2000s when property prices were rising rapidly. They were perceived as an almost fool proof way of making money. Many investors bought properties with for example a HSBC mortgage, rented them out for a while and then sold them taking profits from the increased capital value of the given properties.
With the dramatic fall in property prices since 2007, numerous investors were caught with properties worth less than what they initially paid for them. For a time there was a dramatic fall in the numbers of these type of mortgages being offered and being taken.
Nowadays with very low interest rates and rising rent amounts in many parts of the country, the latest is to purchase properties with the main purpose to generate rental income rather than making profits from housing price increases.
Lenders’ criteria for providing a such a mortgage
Mortgages for residential properties in which the borrower will live in are closely bound to the income of the borrower. In a buy to let finance plan, lenders use different criteria to calculate the mortgage rates. The lender is interested in the rent to interest (RTI) calculation. This means that the borrower will have to demonstrate that the rental income from the property will more than match the required mortgage payments.
Usually the bank will require that the expected monthly rent will cover 125% of the monthly mortgage repayments. Lenders also commonly require borrowers to provide a 25% deposit or even more. Here a mortgage calculator can be utilized to quickly estimate all the numbers.
Lenders also regularly require that first time landlords or those with a small portfolio of properties should have an income of at least £25,000 per year of non-rental income.
Interest only mortgages or repayment mortgages?
While a buy to let mortgage is most often an interest only mortgage rather than a repayment one, different types of landlords will have different needs. Repayment mortgages may be suitable for landlords who see their rental income as being a significant part of their pension scheme or for landlords who only intend to have a small portfolio of properties. With a repayment structured loan, the landlord will have to paid off the mortgage(s) by the time the payment period is complete.
There are other landlords who wish to build up a large portfolio of rental properties. Such landlords usually get an interest only or 100% mortgage. If they have a rental income which comfortably exceeds the monthly interest payments then this positive cash flow can be used to fund deposits for new properties. When the home loans reach their term they are usually paid off by selling the property in question.
There can also be some tax advantages in such an investment strategy as interest payments can be offset against taxes. Potential rental property investors should seek professional advice on the tax implications of various types of buy to let mortgages including a remortgage.
Such a policy is a normally part of a long term investment strategy. It would be risky for those with only a limited or short term investment strategy.
In addition to the deposit needed and interest payments due on the mortgage, there are other costs that the landlord will incur both at the time of purchase and on an ongoing basis on a buy to let house. For a start there are the costs of purchase – legal fees, mortgage advisor fees, stamp duty, survey fees. If the landlord is offering to rent the property as a furnished property, then the landlord will also have to provide, carpets, curtains, beds, furniture, etc.
There will also be ongoing costs for the landlord – maintenance costs, such as for a new boiler. There may also be a gap in terms of rent when one tenant leaves and another comes in. There could be several months of no rental income with the mortgage payments still due. While most tenants are reliable, there is also the possibility of having a tenant who defaults on the rent. Fortunately, there are insurance policies that landlords can take out, at a modest price, to cover rental default shortfalls.
All of these costs need to be factored in before committing to taking out a buy to let mortgage or even a remortgage on any property.
Return on investment – Buy to let mortgage calculator
Ultimately a landlord has to decide whether renting out properties with a home loan is worth the investment or not. The individual needs to work out whether the income from rent is as good as could be obtained by buying stocks and shares or opening a savings account.
In order for landlords to calculate the value of rental income in comparison with any other form of investment, the landlord needs to calculate the return on investment (ROI) of the rental property. The way to do this is to calculate the net rental income as a proportion of the deposit put down for the property
An example below will demonstrate how to calculate the return on investment. This is purely an example for calculating the method of ROI and is in no way a guarantee of anything.
A property is bought for £200,000. Expected rent from the property is £1,000 per month
The landlord gets a £150,000 buy to let mortgage at 5% interest = £625 per month interest payment or £7,500 per year. Using a buy to let mortgage calculator to work out the actual monthly payments due:
£1,000 rent x 12 = £12,000 per year
Difference: £12,000 – £7,500 = £4,500
Deposit plus buying costs = £56,000
Annual Return on Investment £4,500 ÷ £56,000 = 8.04%
With this calculation a landlord can work out whether this type of investment is a good investment compared with other investing options.
Even in an era of falling property prices, taking on home loans to purchase rental properties can be a profitable long term investment if:
Possible short term falls in property prices can be managed.
The landlord can put forward a 25% deposit.
An RTI of 125% can be achieved.
If all of these conditions can be met then it may well be a good investment to look into buy to let mortgage deals.
This document does not constitute financial advice under the Financial Services and Markets Act 2000. If you require such advice, you should seek appropriate professional advice.