How buy-to-let mortgages work - Gareth Shaw

Dear Gareth, I’m tentatively thinking of buying a property in Yorkshire to let out and, if successful, make further investments. I’ll need to borrow some money, but I have a sizable deposit. How do buy-to-let mortgages work? And can I still borrow if I want to own a number of properties in the future?

A row of terraced residential houses.
A row of terraced residential houses.

Gareth says…

It is helpful that you have a decent amount of capital to put down, as in order to qualify for a buy-to-let mortgage you’ll have a minimum of 20 per cent to 25 per cent deposit, meaning that you’ll be able to borrow a maximum of 80 per cent of the value of the property you want to buy.

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Before the pandemic, it was possible to find a few deals that only required a 15 per cent deposit, but the financial uncertainty of the past 15 months has forced the lenders offering those deals to withdraw them from the market.

Typically, buy-to-let mortgages are sold on an interest-only basis. This means that you only pay the interest being charged on the loan on a monthly basis, rather than paying down the capital as you would with a residential mortgage.

Lenders expect you to have a repayment plan in place to pay off your loan when the term ends in 25 to 30 years. This could be savings or investments or other assets you plan to sell. Capital growth, where you count on the value of your property rising over the term of the mortgage, can be used on buy-to-let interest-only mortgage deals.

In terms of costs, the rates will depend on how much deposit you’re putting down and your credit-worthiness, so not all that dissimilar from residential mortgages. But affordability checks are quite different for would-be landlords.

One thing to note - upfront fees on buy-to-let mortgages tend to be significantly higher than those on standard residential deals. When we looked at the market last year, we found that the cheapest deals had fees of up to £2,000.

One thing you will encounter is an ‘interest cover ratio’. This is a calculation used by lenders to work out how much rental income you’ll generate from your property against your monthly mortgage repayments, and lenders will base their lending decisions on whether or not you meet the minimum level.

They test this using a representative interest rate (around 5.5 per cent) which is typically higher than the one you might be paying, to reflect any potential future increase in costs, and look for your projected rental income to be 125 per cent of your mortgage repayments. Some lenders may ask for a higher ratio of 145 per cent to 150 per cent.

Don’t expect the checks to become any less stringent if you want to become a ‘portfolio landlord’, meaning that you own multiple buy-to-let properties. Professional landlords with four or more properties are often described as ‘portfolio landlords’.

Back in 2017, the Bank of England tightened the rules that can make it tougher for these types of landlords to access finance, requiring you to provide mortgage details, your business model and cash flow projections for every single property you own in order to get more funds.

Some lenders put a limit on the number of properties you can have in your portfolio, while interest cover ratios may increase with the number of properties you have and lenders may require the total amount of capital you own in the properties is higher than what you need to get your first buy to let property (say 35 per cent rather than 20 per cent).

Some lenders might consider your personal income as part of its affordability assessment as a portfolio landlord (known as ‘top slicing’), but it’s relatively rare.

I would say that, given your ambitions, professional advice would be essential for you. An independent mortgage broker can scour the market to help you find the right deal for your circumstances and will have access to deals that are only available to intermediaries.

Gareth Shaw is the head of money at which.co.uk.

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