Buy-to-let mortgages are distinct from regular home loans, typically being about 1% costlier with significant fees and a demand for substantial deposits of at least 25%. They function mainly on an interest-only basis, relying on projected rental income. As these mortgages approach maturity, borrowers must consider repayment options. Planning ahead and exploring competitive remortgaging options are crucial to avoid transitioning to higher standard variable rates (SVR). Read more for the full guide.
What is a Buy-to-Let Mortgage?
Buy-to-let mortgages differ significantly from regular home loans. Transitioning to one when renting out your property or seeking it for an investment property may seem intricate. Yet, you must opt for a buy-to-let mortgage for a tenanted property. What sets it apart from an ordinary mortgage?
- Higher Cost: Buy-to-let mortgages are generally pricier, typically by about one percentage point, compared to residential mortgages. Banks perceive tenants as riskier borrowers than homeowners.
- Substantial Fees: Some buy-to-let mortgages come with considerable arrangement fees, often reaching up to 3.5% of the property’s value.
- Interest-Only Payments: The majority of buy-to-let mortgages entail interest-only payments. This structure lowers monthly costs as landlords only cover the interest, with the capital to be repaid when the loan matures, usually after 25 years, typically through property sale.
- Rental Income Basis: You don’t face the same affordability assessments as regular mortgages. Instead, you typically need to demonstrate that your monthly rent will cover at least 125% of the interest-only mortgage payment. Many lenders employ their standard variable rate (SVR) for this calculation, not your initial fixed rate. For example, if your mortgage (on the SVR) is £500 monthly, you’d need to charge at least £625 in rent.
- Additional Expenses: Lenders factor in an extra 25% to cover expenses like letting agent fees, maintenance, insurance, and safety checks. Be mindful of these costs in your calculations.
- Substantial Down Payment: To secure a buy-to-let mortgage, you must provide a deposit of at least 25% of the property’s value. For instance, if you were purchasing a £100,000 house, your savings would need to cover £25,000.
Why invest in buy-to-let?
The era of low interest rates previously enhanced the allure of buy-to-let investments. With savings generating meager returns and affordable mortgages, it appeared to compensate for the 3 percent stamp duty surcharge on buy-to-lets and second homes, which substantially ate into profits, along with the reduction in full mortgage interest tax relief that dampened returns.
However, the landscape has evolved. The Bank of England has raised the base rate significantly, soaring from 0.1 percent in December 2022 to 4.25 percent by March 2023, resulting in notably higher buy-to-let mortgage rates.
So, is it still a lucrative venture? Many remain optimistic but have adopted a more cautious approach, as evidenced by our recent visit to the National Landlord Investment Show.
Buy-to-let continues to appear attractive as an income investment, particularly for those with substantial funds to secure a sizeable deposit. This attractiveness persists in contrast to the dismal savings rates and volatility of the stock market.
However, mortgage rates have substantially risen from their historical lows, rendering it more challenging for buy-to-let investors to secure favorable deals.
How buy to let mortgages work?
One notable distinction lies in the fact that the majority of buy to let mortgages operate on an interest-only basis. Consequently, your monthly payments solely cover the loan’s interest, leaving the principal amount untouched. While this results in lower monthly payments, you must be prepared to either settle the entire loan, sell the property, or refinance at the mortgage term’s conclusion. Essentially, you can purchase the property, generate rental income for the agreed term (e.g., 25 years), and subsequently repay the mortgage by selling the property.
Repayment mortgages, where both capital and interest are repaid in monthly instalments, are infrequent in the realm of buy to let properties. Implementing such a mortgage would necessitate charging higher rent to cover the increased monthly cost. Nonetheless, this arrangement grants flexibility at the mortgage’s end, allowing you to continue renting and retaining the full rental income or selling the property without mortgage obligations.
Another pivotal disparity between residential and buy to let mortgages pertains to the borrowing amount. In the buy to let context, your borrowing capacity is determined by the projected rental income, not your personal income. Therefore, if the property boasts size or an ideal location, you can command higher rent, consequently securing a more substantial mortgage.
The third distinction lies in the deposit requirement. Buy to let mortgages are perceived as riskier by lenders, leading to a common stipulation of a larger deposit, typically around 25% or more. Similar to standard mortgages, a larger deposit enhances the attractiveness of mortgage offers, so it’s advisable to provide the most substantial deposit possible.
What Happens when My Buy-to-Let Deal Comes to an End?
Plan Ahead: Taking action a few months before your initial fixed or variable rate expires is crucial.
Explore Competitive Options: Check out our top-value offers to see if you can switch to another affordable rate through remortgaging. Otherwise, you’ll automatically transition to your lender’s standard variable rate (SVR). These typically come with higher rates than the broader market, leading to a significant hike in your monthly payments.
Consider Fees: Keep in mind that buy-to-let arrangement fees can be substantial, making frequent remortgaging for a lower interest rate costly. In such cases, you might opt for a more extended term deal, say five years, if you’re confident you won’t need to sell the property during that period.