Expert advice on buy to let mortgages

Q. I have recently received a small windfall from a favourite aunt and would like to purchase a buy to let property rather than invest in stocks and shares.  However, after having carried out a little research, I’ve discovered that the tax rules for landlords have changed significantly recently.

Will this affect how much I can borrow?

A. You’re right, taxation on private landlords has changed with the introduction of a series of measures referred to as “Section 24”. Effectively, this means that the ability to claim tax relief on the interest portion of your buy to let mortgage payment is being reduced, so that by 2020 you won’t be able to claim any tax relief on your mortgage payment at all as a landlord.

In addition, according to guidance from HMRC, the way that tax on rental income is calculated has also changed, meaning that for many landlords, any rental income is added directly to their earned income, then charged at the appropriate rate.

This means that higher rate tax payers now pay more tax on their rental income than lower rate tax payers. Another factor is that depending on how long

a landlord owns a property that’s been let out, there may be Capital Gains Tax to pay when the investment property is eventually sold, as well as any tax paid on rental income.

The amount of tax that you will pay on your rental income may also impact how much a lender will advance you on a buy to let mortgage, meaning that, ironically, higher rate tax payers may find that they aren’t able to borrow as much as those who pay rate at a lower rate.

There are ways to legally mitigate the amount of tax that you will pay on a buy to let investment, but it’s important that you take advice from an accountant before you proceed as this is a specialist area that mortgage advisers aren’t able to provide guidance on.

But it’s not just the tax situation that you need to be aware of. In 2017, buy to let underwriting criteria changed as a result of new rules implemented by the Prudential Regulation Authority (PRA).

As a result, lenders have to “interest rate stress test” applicants for buy to let borrowing to ensure that they can afford to continue to pay the mortgage should interest rates rise again.

The most common rate used in “stress test” scenarios is 5.5 per cent, although if you’re taking out a longer-term fixed rate, such as five or ten years, then the rate used for these assessment calculations may be lower.

However, the stress test rates do vary from lender to lender, so it’s important to understand the criteria involved before you apply.

Another element of the affordability process is the “rental stress” calculation.  Some lenders require a monthly rental income of 145 per cent of the mortgage payment, whilst others will consider 125 per cent.

The reason they do this is so that they can make sure that the rental income will not only cover the mortgage, but will also cover for voids – periods when the property is not let out and therefore there is no income –  and for any management charges if you

use a letting agent as well as any necessary repairs or maintenance to the property.

As applying for buy to let borrowing is such a complex process, speaking to a mortgage broker with extensive experience in the sector can pay dividends, especially if you’re embarking on the process as a first time landlord.