Buy-to-let mortgages are for people purchasing property with the intention of letting it out to tenants. If you’re contemplating becoming a landlord, here’s what you need to know about buy-to-let mortgages.
What are buy-to-let mortgages?
As the name suggests, buy-to-let mortgages are specifically for the purchase of a property to let out to tenants rather than to live in yourself. However, proceed with caution because investing in any property is risky business, especially if you’re going to rely on someone else to pay you rent in order for you to pay the mortgage.
How do they work?
Instead of using your salary to pay off your mortgage, as you do with an ordinary mortgage when you intend to live in the property you buy, a buy-to-let mortgage lends you the capital to buy a property which you then rent out and use the rental income from to pay your mortgage repayments.
While your salary is the key factor used to determine your ability to borrow when buying a home that you’re going to live in, when you’re buying to let lenders will generally look at the potential rental income of the property to help them make a decision as to whether to approve your loan, as that’s what you’ll be using to make the repayments on the mortgage. Most lenders require a rental income of between 25-30% more than your mortgage repayments.
This doesn’t mean that lenders won’t look at your salary though. If it’s your first buy-to-let application your lender will probably want to know how much you earn to ensure you’ll be able to make repayments.
You may also need to provide evidence of how you intend to pay the mortgage if the property isn’t let for a lengthy period of time – which is always a risk with rental properties. If you can’t provide evidence to reassure lenders that your loan will be repaid, they’re unlikely to agree to lend you the money in the first place.
How do they differ from a normal residential mortgage?
While a buy-to-let mortgage is very similar to an ordinary mortgage, there are a number of key differences which you need to factor in when considering buying a property to rent.
The risk factor of a buy-to-let property is much greater than that of a property intended to be lived in by the owner. As such, buy-to-let mortgage interest rates are generally higher.
You can expect to pay around 1-2% more in interest rates for a buy-to-let mortgage. As with all mortgage deals, it pays to shop around to find the right deal for you.
Set-up fees also tend to be higher with a buy-to-let investment, so make sure you factor this in when working out how much the property will cost you to buy overall.
Most buy-to-let mortgages are offered on an interest-only basis. This keeps the cost of repayments lower than a repayment mortgage as you’re only paying off the interest on your loan every month.
However, as you’ll still need to pay the remainder of the mortgage off at the end of the term, your lender will want to ensure you have some way of paying off the outstanding balance. You may sell the property to pay off the mortgage (providing its value hasn't fallen), or you may have a separate investment plan that you’ve been topping up during the lifetime of the mortgage.
While it’s possible to get an ordinary residential mortgage with a deposit of just 5%, you’ll need considerably more for a buy-to-let mortgage. The majority of lenders ask for a deposit of around 25% of the value of the property, although this can vary between 20-40% depending on the provider.
Other things to know
Unlike residential mortgages, most buy-to-let mortgages aren’t regulated by the Financial Conduct Authority (FCA). The reason being that instead of borrowing money to buy a property to live in, you’re borrowing to fund a venture you intend to make money from.
As such, you’re viewed as a commercial borrower and it’s assumed that you have a greater understanding of the lending agreement than someone buying a home to live in. Therefore, you don’t need to be protected by the FCA.
However, this does mean that you have very little means of redress if you discover at a later date that the mortgage you’ve purchased is unsuitable for your needs and you won’t be able to claim compensation for any product you believe you have been mis-sold.
It’s therefore essential that you read the terms and conditions for a buy-to-let mortgage before you sign on the dotted line. Some lenders add additional criteria to their loans which could determine who you are allowed to rent to and for how long.
For example, you may not be able to rent out your property to multiple occupants with no connection to each other, or there may be a limit as to how many buy-to-let mortgages you can have.
Whether you think you’re mortgage savvy or not, it’s a good idea to get advice from a financial adviser before you take out a buy-to-let mortgage to ensure you get the right product to suit your needs.