What to Consider When Buying your First Buy to Let
You’ve decided you want to become a landlord, but first you want to know a bit more about how they work and what other considerations you may want to consider. Buy to let mortgages are for landlords who want to purchase a property and rent it out. If this is your first buy to let, you are bound to have questions. In this buy to let guide we will go over the main areas to consider to help you become more confident about how a buy to let mortgage works and what things to consider.
Please note most Buy to let mortgages are not regulated by the Financial Conduct Authority.
Usually interest rates for buy to lets will be higher than a residential mortgage.
The minimum deposit limit is usually set around 20%-25% depending on the mortgage lender.
Most landlords take out mortgages on an interest only basis. This means you pay a lower monthly payment as you are only paying the interest and not the capital. This helps maximise your profits but the mortgage balance will remain the same. You can have a repayment mortgage if you wish but most choose interest only.
If you do decide to have an interest only mortgage, then you will need to have a repayment strategy. In most scenarios this will be sale of the property at the end of the term, but this can be discussed in more detail with a mortgage adviser.
Types of BTL Properties/Mortgages
There are two main routes to purchasing your first buy to let property. You can purchase it in your personal name or via a limited company. If you purchase in your personal, any income generated will form part of your income and you will have to pay tax on this income. If your purchased the property via a limited company then the income is paid to the limited company and you would need to draw funds from the company. For more infomration we have written a separate guide detailing the differences and most common reasons for choosing one or the other.
How is Income Assessed?
The maximum amount you can borrow is determined by the value of the rental income you expect to receive, as well as the deposit you are willing to put down.
Buy to Let mortgages are assessed on the rental income the property is likely to generate. Lenders will also apply a ‘stress test’ to your application, factoring in your ability to pay an interest rate of between 5.5% to 6%, even if the actual mortgage rate is lower. This is the stress income cover ratio and is applied if interest rates do rise to that level. As a result of interest rates rising the stress test has also increased. Lenders will typically need the rental income to be at least 125% of the monthly mortgage payments but can be as high as 145%, depending on a lender’s criteria.
Some lenders require you to have a minimum income from other sources to guarantee that you have other financial resources to rely upon, should you have problems with income from tenants or gaps in rental.
What if my Rental Income Does not Pass the Stress Test?
Top Slicing is an approach sometimes adopted by lenders to help landlords get a mortgage when their planned rental income falls a little short of the 125% usually required.
It allows borrowers to use other income to prove affordability – either from their wider property portfolio or personal income.
Why do Lenders Complete a Stress Test?
It is not always possible to guarantee tenant occupancy for 52 weeks of every year and sometimes repairs or refurbishments may be needed.
It is generally necessary to have some cash put aside to take care of emergencies, so lenders want to see that you can build up savings for these potential eventualities.
How Much can I Borrow?
The amount you can borrow is tied to how much income the rental property can achieve. Have a look at the rental market in the area with the same type of property you are considering purchasing.
When you apply for a mortgage, the surveyor will do these checks and will estimate a rental figure which the lender will use for their calculation. So, by doing your research earlier you can be confident your figures are correct and the likelihood your mortgage will be approved is higher.
Why it Saves Time to Use a Mortgage Broker
All lenders have slightly different criteria, you could be a perfect match for one lender, but another lender will decline your application due to the fact they have differing criteria. This is why it is important to use a mortgage broker. They are experts in their field and will make sure you fit the criteria before submitting any application. This saves time, money and your credit score. Below are some of the possible restrictions some lenders apply.
- Some lenders require you to have a minimum income of £25,000.00
- Some lenders require you to already have a residential mortgage or have had one in the past.
- In this scenario a lender may stipulate that you must have and lived in your current property for at least six months before applying
- Some mortgage lenders are intermediary only which means you have to go through a mortgage broker if you want to be sure you are getting the best deal.
- Energy Performance Certificate (EPC) – There are new rules to come into place restricting buy to let properties to level C. Please see our news on this for more information.
I Am Thinking of Purchasing a Flat
If you are purchasing a flat please be aware of the rules on properties that contain cladding on the building. Not all flats including cladding, but if the property you are interested in purchasing is then the following information surrounding EWS1 forms could be important for you to consider
External Wall System Form (EWS1)
An EWS1 form is required on buildings, usually a block of flats, which includes cladding and other material on the outside of the building to assist with fire safety. An EWS1 form is valid for 5 years and it is the responsibility of the buildings owner to make sure this report is completed and maintained. Unfortunately, we have seen clients looking to purchase properties which do not have the EWS1 form completed. Without it a lender will not offer a mortgage and this has caused delays for our clients, so we would advise to always ask for this at the start The general rules are as followed.
For buildings over six storeys, an EWS1 form should be required where:
- there is cladding or curtain wall glazing on the building
- there are balconies that stack vertically above each other and either both the balustrades and decking are constructed with combustible materials (e.g. timber) or the decking is constructed with combustible materials and the balconies are directly linked by combustible material
For buildings of five or six storeys, an EWS1 form should be required where:
- there is a significant amount of cladding on the building
- there are ACM, MCM or HPL panels on the building
- there are balconies that stack vertically above each other and either both the balustrades and decking are constructed with combustible materials (e.g. timber), or the decking is constructed with combustible materials and the balconies are directly linked by combustible materials
For buildings of four storeys or fewer, an EWS1 form should be required where:
- there are ACM, MCM or HPL panels on the building
This is for guidance only for the full set of rules please go to www.rics.co.uk
What are the Tax Rules?
If you decide to purchase the property in your personal name. The first £1,000 of your rental income is tax-free as your ‘property allowance.’ If you make between £2,500 to £9,999 profit after allowable expenses, or £10,000+ before allowable expenses, you need to pay tax via an annual self-assessment.
We would always advise speaking to an accountant/tax adviser when it comes to tax and what you will need to declare on your returns.
Capital Gains Tax
If you sell a buy to let property in your own personal name and make a profit, you will pay Capital Gains Tax (CGT) should your gain be above the threshold for the relevant tax year.
Extra Costs To Consider
While lenders will make sure you can afford to pay back your mortgage each month, there are also other costs to consider as a landlord. We’ve put together some of these costs below:
- Energy Performance Certificate – An EPC shows tenants how energy efficient the property is. While this is generally a small cost it is something that will need to be completed before any viewings are taken making it an upfront investment in the property. (Rules on EPC’s are changing – click here for more info)
- Electrical Safety Inspection Report – Since July 2020 landlords are obligated to get an electrical safety report to make sure that all national standards for electrical safety are met. This must be renewed every 5 years.
- Gas Safety Certificate – A gas safety check is another legal requirement and must be completed annually.
- Smoke/Carbon Monoxide Alarms – All landlords are required to fit smoke and carbon monoxide alarms
- Letting agent fees
- Landlord License – Certain boroughs require landlords to register and obtain a landlord license before you can let out your property.
- Landlord insurance –At a minimum, you’ll need building insurance to get your mortgage but landlord insurance can also cover emergency call outs as well as legal expenses and is something to consider