Buy-to-let mortgages: what do you need to know in 2018?
By Bea Patel on 5 Nov 2018 in Letting
In this article, Matt Stevens, director at The Mortgage Genie looks at buy-to-let mortgages and what would-be landlords need to know in 2018.
Buy-to-let (BTL) mortgages have undergone quite a few changes in the last few years, which has put off quite a few people from getting involved. However, the average five-year fixed BTL has recently fallen to 3.40 per cent, the lowest level on record (Moneyfacts), showing that lenders are still confident in the future of the market. And, because rates are so low, it’s a great time to get involved if you’ve been thinking about becoming a landlord for the first time.
To help you make an informed decision, I’ve put together a quick guide to buy-to-let mortgages in 2018. I’ll cover how they work, different types of BTL mortgages, who can apply for one and the tax situation surrounding them.
How do buy-to-let mortgages work?
Buy-to-let mortgages are designed for people who want to become landlords but don’t have the funds to purchase a property upfront. They work much in the same way as regular mortgages: you’ll get a loan that covers the value of the property and you’ll repay it over an agreed term. However, there are two types of BTL mortgages, both of which differ in how they’re repaid.
Interest-only buy-to-let mortgages
With an interest-only buy-to-let mortgage, you only pay the interest on the loan you’ve taken out, with the amount borrowed – known as the principle – repaid at the end of the agreed term.
But, as this can involve paying back a large sum, you’ll need to be well aware of the options for repayment well in advance and plan your finances accordingly. If you can’t afford this, you can choose to sell the property or remortgage.
Investors are attracted to interest-only BTL as it’s the best way to keep monthly repayments as low as possible, but there’s always the large amount of outstanding debt to consider. If you’re able to invest in a property that increases in value over the loan term, you stand to make a profit should you decide to sell it and repay the mortgage loan. But, as there has been a volatile property market in the past few years, there aren’t any guarantees.
Repayment buy-to-let mortgages
A repayment buy-to-let mortgage is similar to a regular mortgage loan, with both the interest and some of the capital repaid each month.
As you’re building equity in the property over time, by the end of the loan term you will own it outright, so there’s no need to sell or remortgage. However, your repayments each month will be higher. This type of BTL mortgage is usually preferred by landlords who only have one or two properties in their portfolio and don’t want to worry about a large debt later.
Who can apply for a buy-to-let mortgage?
Like any mortgage, a buy-to-let mortgage provider will scrutinise your application to make sure you will be able to afford a loan before finalising a deal. While they’ll consider your income, deposit size, and spending like a residential mortgage, they will also look at the potential rental income.
And, because BTL loans pose a bigger risk to the lender, they’re likely to apply even stricter demands for applicants. Let’s look at the essential criteria you need to meet to secure a mortgage:
- Potential rental income: A lender needs to know you’ll be able to afford the repayments on a BTL mortgage, so they look at something called the rent-to-interest cover calculation. This works out the ratio of your projected rent income versus the total interest payable across the loan term. Through this, they’re able to predict whether you’ll successfully repay the mortgage.
- Salary: In addition to rent, lenders also want to know about your other income, especially your salary. A common requirement is to earn at least £25,000, so that a loan provider can be sure you’re able to repay the mortgage should the property become empty or your tenants miss a rent payment.
- Age: Many lenders will also judge your application by your age, as they want to ensure you will be able to make repayments for the whole loan term. This means that if you’re aged 75 or over, it could negatively affect your chances of securing a BTL mortgage. There is often a minimum age of 25, too.
- Deposit size: You’ll need to provide a deposit for a BTL mortgage, and, because they carry more risk than residential loans, it will usually need to cover a larger percentage. This will usually be between 20–40 per cent of the property’s value.
What are the buy-to-let Income Tax relief changes?
In 2017, the buy-to-let market underwent regulation changes as to how landlords pay tax. Under the previous buy-to-let Income Tax relief system, landlords could claim back relief on financial costs. Instead, a new 20 per cent basic rate of tax relief will be put in place.
These changes are being phased in: the process began in April 2017, when only 75 per cent of mortgage interest could be offset against profits. In 2018, this fell to 50 per cent, 2019 will see it fall to 25 per cent, and by 2020 it will be 0 per cent. The system puts an end to the tax advantage landlords had enjoyed previously, and costs will increase as a result.
Many landlords have begun adjusting to this new system by adopting two tactics. One is to incorporate their business, setting up as a limited company so that you only need to pay Corporation Tax. Another is to transfer ownership of the property to someone else below the Income Tax threshold, as they won’t need to pay.
Hopefully, this article has given you a good overview of buy-to-let mortgages and the process of becoming a landlord. With rates so low at the moment, it’s well worth exploring this option as another stream of income.