Your choice of the right buy to let mortgage can make a huge difference to the returns that you hope to make from investing in buy to let property. You should also note that getting a buy to let mortgage has become much more difficult because of the credit crunch. This article will give you some tips to help you get the best buy to let mortgage as well as to manage it.
Before the credit crunch started in 2007, getting a mortgage was usually the last thing on people’s minds. Brokers and banks were tripping over themselves to lend money to residential landlords. Not too many questions were asked about deposits or rental cover or the landlord’s ability to keep servicing the mortgage in the event of the property being vacant for a long time. Instead of demanding the 25% deposits that had been standard for many years, many banks were lending at up to 100% of LTV (loan to value). At that time more than one in ten new mortgages being issued by banks went to buy to let landlords.
Since then banks have completely closed the taps on the best buy to let mortgages. Finding a mortgage has been as tough as finding a beach umbrella in Antarctica. The number of different buy to let mortgage products collapsed by as much as 95%. Even where banks are lending they are being much more picky about which clients they take on and also which properties they are willing to lend against. Buy to let mortgage rates have also shot up a lot. But if you know what you are doing, have the right deposit and property, then you will still be able to get a bank to lend you the money for your property.
Which sort of buy to let mortgage?
First you need to decide what sort of mortgage you want. Traditionally most buy to let property owners have chosen to go for an interest only mortgage. It does what it says on the tin. On this sort of mortgage your monthly payments cover the interest only. The principal amount that you owe doesn’t change at all so even after paying this sort of mortgage for 20 years you will still owe exactly as much as you borrowed. The reason most landlords go for this sort of mortgage is because they can deduct the interest they pay from the rent they receive when filling out a tax return. By not paying off more of the principal, landlords get to minimize the tax they have to pay. But it does leave them reliant on rising property prices to pay of the mortgage.
The second option is a normal mortgage where each month the interest is paid and a small amount of capital also gets paid off. This way at the end of the term of the mortgage (which is usually 20 years but can also be 25 years) the whole amount has been paid off. This is less tax efficient but it is a less risky strategy, especially for a small landlord with only one or two buy to let properties that are intended to finance a retirement. As the mortgage gets reduced the landlord also frees up equity that can be used to finance further property purchases.
The next thing to remember is that the best mortgage for one person will not be the same as the best one for another. Much of which mortgage you choose will depend on your individual circumstances (including whether you are a higher-rate taxpayer) and your tolerance for risk. It also depends on your outlook for the property market. If you think prices will keep rising then it makes sense to minimize income tax and pay off the property through selling it. That way most of your profit will be taxed as a capital gain, which is a lower rate than income tax.
Fixed or variable mortgage?
In the past most landlords simply took out a variable rate mortgage. Depending on where you are in the rate cycle these can be a lot cheaper than fixed rate deals. They are also more flexible should you wish to sell. The disadvantage is that being on a variable rate mortgage will expose you to the risk of rates going up a lot. You may wish to bet that they can go down, but where we stand now with the Bank of England rate at a record low, it is almost impossible to see mortgage rates falling much.
The real risk is that as the economy heats up again that rates may rise. And if inflation picks up they may rise a lot. A fixed rate for 3-5 years is probably more appropriate for beginner buy to let landlords as it allows you a fixed idea of how much you will have to budget to pay each month. Banks may also be more willing to grant one of these as they would see it as less risky.
Given all of the risks you already have to take on such as worrying about property prices, rents and managing your property, eliminating one of the key risks seems a good idea. Be prepared, however, to have to pay a much higher fee for a fixed rate mortgage compared to a variable rate. And be prepared for exit penalties if you pay it off early.
Make yourself eligible for the best deals on landlord mortgages
Since banks pulled back from the buy to let property market after the collapse of Northern Rock, a huge number of potential borrowers have been excluded from the property market. Banks have essentially refused to lend to anyone with anything less than a 25% deposit. They are also being more strict about how much rent a property must generate relative to the mortgage before they will agree to a loan.The interest rates on buy to let mortgages have also shot up in recent years and they are much higher than those for normal residential mortgages.
To be sure to get the best deal with the lowest rate you need to be sure you are attractive to mortgage lenders. These are some of the things they will look for:
1. A big deposit. In many areas and for certain properties banks will demand a deposit of as much as 40%. In some cases they will lend against smaller deposits but they may charge a higher rate. To get the best deal make sure your deposit is comfortably above the minimum. It may even make sense to sell some other investments to raise cash if by adding a few thousand pounds to the deposit you are able to secure a much lower rate
2. Houses or flats in good areas. When banks got badly burned in the crash most of the pain was felt in particular segments of the markets. These were new-build apartments, especially in city centers, where mortgage fraud was rife. Many banks are now simply refusing to lend against off-plan developments and new build without deposits of 40% or more. Banks are also wary of areas where there has been a lot of new building in the past few years and where there is now more capacity than demand. These included areas with traditionally weak property markets that were sold to investors on the idea that they were being regenerated. Avoid these areas unless you are sure you can buy at a very good price.
3. Good rental cover: Banks are keen to see landlords with properties that can get enough rent to cover 125% of the interest payments on the mortgage. That way the landlord has enough to cover rental voids (these are periods when the property stands empty) and pay for essential maintenance. Essentially they want to be sure that you won’t be missing payments so the more you can do to show them that this is unlikely, the better off you will be. Reports from letting agents in the area may help you support your case, but don’t be tempted to fiddle the figures. You will firstly hurt yourself but also set yourself up for a failed application as the banks do their own research too.
Much of the advice that relates to choosing a good property for buy to let will also help you when it comes to borrowing. If you follow the three rules of buy to let investing and get the right property in the right area at the right price is the route to making money from buy to let. And if you can show your bank that you are likely to make money, they will offer you a better deal and you stand a better chance of getting the best buy to let mortgage deal in the market.
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