Buy-to-let Mortgages Explained
When buying a property for the purpose of renting it out as an investment to make extra income, you’ll need a buy-to-let mortgage. There are some crucial differences between residential mortgages and buy-to-let mortgages which you’ll need to know if you plan to become a landlord
If you’re thinking of buying a property to rent, becoming a landlord could be a great investment. However, without proper planning it can be a risky venture; non-paying or late paying tenants can cause you to struggle with mortgage payments, and the value of your property could fall over the life of the mortgage.
In this article, we’ll explain the main differences between buy-to-let and residential mortgages, outline who can get a buy-to-let mortgage and how, and summarise the charges you’ll be expected to pay.
Who can get a buy-to-let mortgage?
A buy-to-let mortgage is a type of mortgage which can be used by new landlords and experienced property investors to fund the acquisition of property for the purpose of renting it out.
If you want to enter the property rental market, in most cases a lender will require you to take out a buy-to-let mortgage. In some cases lenders will allow a residential property to be rented if the owner is struggling to sell.
The reason most mortgage lenders separate buy-to-let-mortgages from residential mortgages is because the risk factors are different. As a result buy-to-let mortgages tend to require higher deposits and have different lending criteria borrowers have to meet.
It’s recommended that you earn at least £25,000 a year, or you may struggle to meet the repayments for buy-to-let properties.
The majority of lenders have age limits for buy-to-let mortgages, so you’ll need to be under a certain age when you apply for a buy-to-let mortgage. Many will set the upper age limit between 70-75. If the mortgage product you apply for has an upper age limit, you must be below the upper age limit when your mortgage term is set to end.
What are the differences between a buy-to-let mortgage and a residential property?
Despite their many similarities – requiring a deposit and following monthly repayment schedules – there are some significant differences in how buy-to-let mortgages work compared to residential mortgages.
Most buy-to-let mortgages require a deposit of between 25-40%. There are 20% deposit buy-to-let mortgages available on the market, but they are the exception to the rule.
If you want to become a landlord for the first time, you’ll need to have a significant savings pot. But, why do lenders require such substantial deposits? It’s because landlords present a higher risk to lenders; they can’t guarantee the landlord will always be at full capacity, which means there’s a higher chance the landlord won’t be able to meet repayment schedules using rent money, so they need to consider the landlord’s backup financials.
Buy-to-let mortgages are usually more expensive than residential mortgages, both in terms of interest rates charged and the higher deposit requirement. Many landlords adjust to higher costs by purchasing less expensive properties.
Lenders mitigate this risk through asking landlords to pay down a larger chunk of a property’s value than on a residential mortgage. Lenders further attempt to reduce their risk by requesting that landlords’ rental income is 25-30% higher than the monthly mortgage costs. This gives landlords a cushion should they not be at full occupancy, and means the lender has a greater chance of making their money back.
Important to add, lenders use the value of the proposed rental income to decide how much they will lend.
Buy-to-let mortgages for property investors are most popular on interest only. What this means is that during the course of a buy-to-let mortgage term, the borrower will only pay interest each month on the loan amount, not the capital. When the mortgage term is up, the borrower is expected to pay back the full loan amount. This is usually facilitated using the proceeds from the sale of the property.
Unlike residential mortgages, buy-to-let mortgages aren’t regulated by the Financial Conduct Authority (FCA).
As with residential mortgages, your home may be repossessed if you fail to maintain monthly payments.
How much can you borrow?
The amount you’ll be able to borrow depends on your financial circumstances, your deposit, the type of property you’re looking to buy, the area in which it’s based and the lending criteria of the buy-to-let mortgage you apply to.
Our mortgage calculators will give you an idea of how much you could borrow. Check our buy to let mortgage calculator; by entering the price of the property you wish to purchase and the monthly rent you intend to charge, we’ll be able to give you a representation of how much you’ll be able to borrow.
We also have a rent calculator which you can use to work out how much to charge tenants in order to maintain mortgage repayments or make a profit each month, if that’s your aim, rather than profiting from the property sale proceeds.
Creating a financial safety net
Life as a landlord is unpredictable. Tenants come and go, but mortgage repayments are constantly hanging over your head. You need to keep up with your lender’s payment schedule whether you have tenants or not.
This is why many landlords put profit from rentals into savings accounts dedicated for repaying mortgage costs should tenants miss payments, pay late or leave your property. Over the course of a 20 or 25 year mortgage, this is bound to happen multiple times, so it’s important that landlords are well prepared for such eventualities.
What are the costs of a buy-to-let mortgage?
Property maintenance – you’ll be expected to pay to replace furniture and appliances included in the property should they break down due to general wear and tear.
Safety inspections – landlords are required to guarantee the safety of their tenants. This includes various safety tests; landlords need to provide gas and electrical safety certificates to demonstrate that the property is safe to occupy and that the appliances are in working order.
Insurance – a landlord will need to provide buildings and contents insurance to protect the property from damages. Many landlords also take out legal insurance to cover problems with tenants, including non-payment of rent, anti-social behaviour and the costs of eviction.
Agency fees – should an agency be used to manage tenants, their fees can be quite considerable. They are usually between 10-15% of the rent, and sometimes more.
Legal fees – you will need to hire a solicitor to complete the mortgage paperwork.
Product Fee - there is often a fee to secure the mortgage deal of your choice.
Survey – a surveyor will need to inspect the property prior to it being purchased. They’ll check there are no structural problems and that the property is generally fit for sale.
Stamp Duty – unless you are a first-time buyer, stamp duty on buy-to-let properties is higher than for residential properties. Stamp Duty Land Tax (SDLT) for buy-to-let properties is 3% higher than SDLT for other properties valued at more than £40,000.
Compare buy-to-let mortgages
Buy-to-let mortgages are more complex than residential mortgages, so it’s important that you have all the facts to hand when comparing deals from different providers. That’s why at NerdWallet, we provide free and unbiased comparison tables so you can compare mortgage deals across interest rates, product fees, APRC and monthly cost.
By comparing across each charge, you will get closer to the true cost. Remember to factor in costs like insurance, stamp duty, agency fees and the other fees listed above otherwise you may pay more than you’d accounted for.
John Ellmore is a director of NerdWallet UK and is a company spokesperson for consumer finance issues. John is committed to providing clear, accurate and transparent financial information. Read more