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How Do Buy-To-Let Mortgages Work?

Updated: Nov 24, 2023

If you’re looking to invest in buy-to-let (BTL) property, we’ve got everything you need to know in this guide. Get the lowdown on how buy-to-let mortgages work, how much you can expect to borrow, eligibility criteria, and how to get started.


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What are buy-to-let mortgages?

If you intend to rent out a property after purchase and do not have the capital to buy the property outright, you will need a specific buy-to-let mortgage to seal the deal. You are not permitted to rent out a property that has a residential mortgage attached to it without your lenders prior approval.


How do buy-to-let mortgages work?

Buy-to-let mortgages are not dissimilar to standard residential mortgages; the main difference is how the mortgage is paid and assessed, relying on monthly rental payments rather than personal income to cover the cost. This is riskier for lenders, so their assessment and approval process reflects this. They will be looking at the expected rental income in addition to your personal finances as a measure of affordability.

Does Interest Only make sense?

Buy-to-let mortgages are typically set up on an interest-only basis, meaning that the monthly mortgage payments will consist solely of the interest on the loan rather than paying off the loan itself. If you are seeking immediate income from your property investment you will benefit from this as interest payments are lower than those that are set up on a repayment basis. Interest only will also provide you with more breathing space during any periods in which your property is not tenanted. It could also help you save towards purchasing another investment property should you wish to do so. Depending on your own tax status, an interest only mortgage could also be more tax efficient – you should seek advice from a tax specialist or accountant. NOTE: it is important to remember that when the mortgage term is up, you still owe the total value you borrowed, leaving you to sell the property to settle up or repay the loan by other means.

Interest Only & Repayment Monthly Costs

The below table outlines the likely cost of each option and is a simple indicative example as interest rates / terms will always vary from lender to lender. In this example we have assumed that the property will generate a monthly rental income figure of £1300.


Repayment

Interest Only

Purchase Price

£300,000

£300,000

25% Deposit

£75,000

£75,000

Mortgage Required

£225,000

£225,000

Mortgage Term

25 years

25 years

Interest rate (Indicative)

5%

5%

Monthly payment

£1315pcm

£937pcm

Monthly Profit

-£15pcm

+363pcm


How much can you borrow with a buy-to-let mortgage?


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The amount you can borrow will mostly depend on how much rental income is expected from the property and how much deposit you can offer upfront. A mortgage lender will usually look at measures such as the ICR (Income Coverage Ratio), your age, your current homeownership status, and your personal finances before deciding. The length of a fixed interest rate can also result in a higher loan being offered.


Monthly Rental Income – Income Coverage Ratios

Most mortgage lenders will want to see monthly rent of 25-45% more than the monthly buy-to-let mortgage payment. Income Coverage Ratio (ICR) shows the ratio to which the rental income covers the mortgage payments, tested at a representative interest rate, usually around 6% to 7% but changing as interest rates move up and down. Again, this will be lower with some lenders if you’re happy to lock into a five year fixed interest rate. They stress test this rate on your expected loan at their required coverage percentage, usually 125-145%. Some lenders also stress at the highest level if you’re a higher rate tax payer. Stress testing the buffer will indicate if the loan is still affordable even if interest rates rise and/or your monthly expenses increase. Here’s an example: Property Value = £300,000 Rental income: £1300pcm rent x 12 months = £15,600 per annum Mortgage: £225,000 x 7% = £15,750 per annum ICR = £15,600 / £15,750 = 99% Coverage Result = You Will Need More deposit! If your chosen lender is applying an ICR of 125% and using the above example as a guide, you would need to find an additional £46,750 towards your deposit, as follows: Property Value = £300,000 Rental income: £1300pcm rent x 12 months = £15,600 per annum Mortgage: £178,250 x 7% = £12,477 per annum ICR = £15,600 / £12,477 = 125% Coverage Result = Lenders ICR is satisfied The above examples are simply a guide. In an ever changing mortgage world lenders will always be updating their criteria including their ICR’s. At time of writing and in an attempt to improve the ongoing issue for many landlords in terms of maximising borrowing, several lenders are introducing lower fixed rates. This is however at the expense of a significantly higher upfront arrangement fee which you should also take into consideration.

Eligibility Criteria Summary: What do lenders look at when assessing a buy-to-let mortgage applicant?


Affordability Assessment

Using ICR and stress testing, you must show that the proposed rental income from your investment property can comfortably cover monthly payments at the lender’s required coverage ratio and interest rate. Usually, an ICR of 125% or 145% is needed for an interest rate of 6% or more. The actual ICR rate will be different amongst all the lenders and change when interest rates move up / down.

Age Requirements

Although many lenders are comfortable lending well into your retirement, some will want the mortgage term to end before your 75th birthday.

Deposit

You will need to put down a deposit of at least 25% of the property’s purchase price. Occasionally there may be options with a lower deposit, however the majority of lenders will expect upwards of 25%. This sets the loan-to-value (LTV) ratio at 75%. The bigger deposit you can provide, the better rate you’re likely to get.

ARLA (Association of Registered Letting Agents) Projected Income Report

Although not a necessity for your mortgage application, it is worth speaking to an ARLA registered lettings agent to get a report summarising the rental income projection for the property you are considering purchasing.

Credit History

A good credit record for existing or past debts, mortgage debt or otherwise, is a positive indication for lenders.

Borrower Status

Current homeowners will have more options. However, some lenders may accept first-time buyers in certain circumstances.

Tax Status

Some lenders will apply a higher ICR (typically 145%) if you’re a higher rate tax payer.


How about First-Time Buyers?

Usually, lenders will want you to be an existing homeowner and see proof that you make payments to your own mortgage; however, there may be some exceptions. Speak to a mortgage broker for guidance on specific lenders that may be willing to take on first-time buyers.


It’s also worth bearing in mind that you will not qualify for first-time buyer stamp duty relief if your first property is a buy-to-let, and you will be liable for the second home surcharge on any subsequent house purchase, even if it’s your first self-occupied property.


Limited Company Buy to Let Mortgages

Purchasing your buy to let property via a Limited Company / Special Purpose Vehicle (SPV) offers greater tax efficiency. Whilst you would be taxed at your highest rate if purchasing in your personal name, purchasing through a limited company means that you will pay corporation tax on the profit. This will be particularly attractive if you are a higher rate tax payer. You can also offset more of the ongoing running costs against income via a limited company. Not all lenders currently support Limited Company BTL, so interest rates are typically a little higher as a result. However, lenders generally offer a more favourable ICR calculation, which is particularly helpful whilst in a period of higher interest rates.


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How to apply, and where can you get a buy-to-let mortgage?


Below are the steps you should consider when looking at becoming a landlord and making a buy-to-let investment:

  1. Carefully consider your circumstances; take a good look at your finances, and review your credit reports (this can quickly be done online).

  2. Review the eligibility criteria listed above; while not specific to a lender or product, you will be in a favourable position if you can meet these.

  3. Choose a suitable property; research local areas that give better rental yield, and be realistic about the purchase price, renovations required, ongoing maintenance costs, council tax, energy efficiency and potential rental income. (Also, note that some properties built in a less traditional way may be treated differently, but this will vary from lender to lender)

  4. Get an overview of the current buy-to-let mortgage market by researching online or speak to a mortgage broker; also note that most buy-to-let mortgages are not covered by the Financial Conduct Authority (FCA) due to being seen as business transactions.

  5. Speak with a mortgage advisor or mortgage broker; many buy to let lenders will prefer consumers to go through mortgage brokers or advisors anyway, so this saves you a step.

  6. Be mindful of the proposed Energy Performance Certificate (EPC) changes from 2025, where all newly rented properties will require an EPC rating of at least C from 31st December 2025.

What can a mortgage advisor help with?

  • Providing you with a broader view of the different products offered by BTL mortgage lenders.

  • Assessing your eligibility and documentation and making necessary recommendations.

  • Maximising your chances of first-time approval, saving you time, effort and mortgage fees.

  • Finding the right insurance cover and pointing you to other helpful resources for landlords.

  • Remortgaging; if you decide to remortgage, an advisor or broker will help you get the best mortgage deal, which may not be with your current lender.

  • Guiding you through the application process, acting as the ‘middle man’ between you and the lender. Find out more information here on how long the process takes and the steps of your application.

Is a buy-to-let mortgage worth it?

Do the advantages and potential financial gain of buy-to-let outweigh the time, effort, risks, and disadvantages of going down the buy-to-let investment route; let’s summarise.


Positives of a buy-to-let investment:


Rental Income

Monthly income from your investment property is a big plus, so long as it far exceeds interest payments. Purchasing at the right price, making clever renovation decisions, and having good tenants can improve your chances of making a good profit long term.


Capital Gains

Selling your property at the right time can see you make significant gains from increases in its value. You will need to pay capital gains tax on the residual profit you make. There is no guarantee you’ll sell for more than you paid.


Insurance Protection

If you get suitable landlord protection insurance, you can be protected from paying out in situations such as ‘loss of rent’ periods and tenant-caused damage and repairs.


Portfolio Opportunities

If you’re looking to purchase a number of properties, you may want to consider purchasing them via a Limited Company. There are potential benefits in doing so, mainly around the taxation of rental income. You should therefore seek advice from a qualified accountant / tax specialist to determine the right option for you.


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Negatives of a buy-to-let investment


Vacant Periods

If you don’t have insurance to cover it, periods where your property is vacant will cost you money.


Decrease in house prices

If house prices fall and you can’t sell your buy-to-let property for at least what you purchased it for, you could be left making up the difference from your own pocket.


Interest rate increases

If the interest rate of your buy-to-let mortgage goes up, so will your monthly payments. This is why lenders are so keen on stress testing with an elevated rate, but even so, there is always the risk that interest rates could rise further.


Tax

You will need to pay tax on your gains from selling the property and tax on the monthly income you make above monthly interest payments (or mortgage repayments). This will need to be declared on your self-assessment tax return.


Higher Stamp Duty

Buy-to-let stamp duty land tax is 3% more than standard rate bands for properties.


Tenant Disputes

If you don’t have suitable landlord protection insurance, you could find yourself paying out for tenant disputes and repairs for tenant damage.


Higher Costs

The costs that come with a buy-to-let investment are sometimes underestimated, and many are higher than you might get with a residential mortgage. Here are the costs you should be aware of:

  • Solicitor Fees

  • Mortgage Broker Fees

  • Mortgage Arrangement Fees and Exit Fees

  • Deposit

  • Interest Payments

  • Stamp Duty

  • Renovation Costs

  • Letting Agent Fees

  • General Maintenance Costs

  • Unexpected Repairs and Bills

  • Landlord Insurance

  • Capital Gains Tax

  • Income Tax

If you think that buy-to-let is the right decision for you, contact Beechwood and speak to one of our mortgage advisors today. Published by Beechwood Mortgages Ref: 219335 with review and approval from Stonebridge Mortgage Solutions Limited who is authorised and regulated by the Financial Conduct Authority Ref: 454811.

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