If you’re considering buy-to-let, it’s crucial to grasp how it functions, along with the associated options and hurdles tied to a buy-to-let mortgage.
What is a buy to let mortgage?
A buy-to-let mortgage is designed specifically for properties intended for renting. If you plan to rent out your property, you need this type of mortgage. It shares similarities with a standard mortgage, where you borrow a significant amount for a fixed period. However, since you won’t reside in the property, there are key distinctions to consider.
How do buy-to-let mortgages work?
Most buy-to-let mortgages operate on an interest-only basis. This means you’ll only cover the loan’s interest each month, not the capital. While it lowers monthly expenses, you must plan to repay the loan or refinance it by the end of the term.
Buy-to-let mortgages share similarities with regular mortgages but come with notable distinctions:
- Fees are typically higher.
- Interest rates tend to be elevated.
- The minimum deposit usually stands at 25% of the property’s value, although it can vary (20-40%).
- Most buy-to-let mortgages follow an interest-only structure, where you pay monthly interest but not the principal amount.
- The full loan is repaid at the mortgage term’s end. Repayment options are also available.
- The majority of buy-to-let lending falls outside the Financial Conduct Authority’s (FCA) regulatory scope. However, exceptions exist, such as when letting to close family members. These are known as consumer buy-to-let mortgages and adhere to strict affordability rules similar to residential mortgages.
- Activities related to advising, arranging, lending, and administering consumer buy-to-let mortgages are regulated by the FCA under the same laws as residential mortgages.
Who can get a buy-to-let mortgage?
To secure a buy-to-let mortgage, lenders often impose specific conditions that vary between providers. These conditions might include:
- Ownership of your primary residence, either mortgage-free or with an outstanding mortgage.
- A solid credit history and manageable existing debts, like credit card balances.
- Proof of separate income, typically exceeding £25,000 annually, apart from rental earnings.
- Age restrictions, usually around 75 years, although some lenders may set lower limits.
- A loan-to-value (LTV) ratio requirement, often at least 75%, necessitating a minimum 25% deposit.
- Borrowing limits determined by your rental income, which should be at least 125% of your mortgage payments.
How much can you borrow for buy-to-let mortgages?
The maximum borrowing amount is tied to your expected rental income. Lenders aim for your property’s rental income to not only cover the mortgage payments but also provide a surplus.
Typically, lenders seek rental income that’s 25–30% more than your mortgage payment. If the property’s rental valuation falls short, it might affect the required loan-to-value (LTV), necessitating a larger deposit. To estimate potential rent, consult local letting agents or online rental listings for rates on similar properties.
How much deposit do I need for a buy-to-let mortgage?
To get an investment property mortgage, you’ll usually need a deposit of at least 20-25% of the property’s value.
Like regular home mortgages, a larger upfront deposit typically means better interest rates. The best buy-to-let deals are usually for investors with 40% or more to put down.
Lenders consider your current property portfolio and past buy-to-let borrowing and repayment history in their affordability assessment.
Buy-to-let and tax
1. Capital Gains Tax
For individuals in the basic tax bracket, selling second properties like buy-to-let incurs an 18% Capital Gains Tax (CGT). Higher or additional tax bracket individuals face a 28% CGT rate. In contrast, other assets have a basic CGT rate of 10% and a higher rate of 20%.
If you make a profit selling a buy-to-let property, CGT applies once the gain exceeds the annual threshold, set at £6,000 for the 2023/24 tax year. Couples co-owning assets can combine this allowance, potentially allowing gains of up to £12,000 (in 2023/24) during this tax year.
To reduce CGT, you can deduct expenses like Stamp Duty, solicitor fees, estate agent fees, or losses from selling a buy-to-let property in a previous tax year from any capital gains.
Any property sale profit must be reported to HMRC, and the applicable tax settled within 30 days. The capital gain is integrated into your overall income and taxed at your marginal rate (either 18% or 28%). Importantly, you can’t carry forward or backward any unused CGT annual allowance, so it must be used in the current tax year.
2. Income Tax
Rental income is taxable and should be reported on your Self Assessment tax return for the relevant tax year. In England, Wales, and Northern Ireland, the tax rates range from 20%, 40%, to 45%, depending on your Income Tax band. In Scotland, rates may be 19%, 20%, 21%, 42%, or 47%.
You can deduct certain allowable expenses like letting agent fees, property maintenance, and Council Tax from your rental income to lower your tax liability. Tax applies to rental income only if it exceeds your personal allowance for the tax year.
3. Mortgage Interest Tax Relief
Landlords can no longer deduct mortgage interest from rental income to reduce their tax liability. Instead, a tax credit equal to 20% of the mortgage interest component is provided. This change may lead to a higher-than-expected tax burden.