When you buy a property as an investment, you won't be able to fund your purchase with a typical residential mortgage. Instead, you'll need a specialist buy-to-let mortgage. There are lots of deals out there, whether you're a first-time landlord or an experienced investor. In this short guide, you can learn the basics of how buy-to-let mortgages work in the UK and get to grips with how lenders will calculate your affordability.
How do buy-to-let mortgages work?
The vast majority of buy-to-let mortgages are provided on an interest-only basis. This means that, for each month of the mortgage term, you'll only need to pay the interest on the loan, and none of the capital. While this can be good news in the short term as your outgoings will be less each month, it's imperative that you have a plan in place to either pay off the full loan or refinance at the end of your mortgage term.
Buy-to-let mortgage rates and fees
Buy-to-let mortgage rates have dropped considerably in recent years. In November 2018, the average fixed-rate buy-to-let mortgage had an interest rate of 3.25%, down from 4.38% five years earlier, according to data from Moneyfacts.
Variable-rate deals followed a similar pattern, with rates dropping from 4.28% to 3.22% between 2013 and 2018.
Average buy to let fixed rate mortgage cost
How much deposit do I need for a buy-to-let mortgage?
To get a mortgage on investment property, you'll usually need a deposit of at least 20-25% of the value of the home. Moreover, as with standard residential mortgages, the bigger the deposit you put down, the better the rate you'll be able to get. The very best buy-to-let deals are usually only available to investors with deposits of 40-50%. However, many investors calculate their cash flow using 75% Loan-to-value ratio. When assessing your affordability, lenders will consider your current portfolio and any previous history of obtaining and paying off buy-to-let finance in the UK.
Interest cover ratios on buy-to-let mortgages
As part of their affordability assessments, lenders use interest cover ratios (ICRs) to calculate how much profit a landlord is likely to make.
A lender's ICR is the ratio to which a property's rental income must cover the landlord's mortgage payments, tested at a representative interest rate (most banks currently use 5.5%). Lenders are required to test at 125% (meaning the projected rental income must be 125% of the landlord's mortgage payments), but many impose stricter rules.
Buy-to-let mortgages for first-time buyers
If you're struggling to get on to the property ladder in your area, you might be considering buying an investment property elsewhere and letting it out. It is possible to get a buy-to-let mortgage as a first-time buyer - but it's not necessarily easy.
For example, you might need a bigger deposit than other investors to get a good deal, as the number of mortgages available to you may be significantly smaller. You'll also be giving up on some benefits available to first-time buyers - especially when it comes to stamp duty. This is because, if your first property isn't one that you will live in yourself, you won't qualify for first-time buyer relief.
On the plus side, as a first-time buyer, you'll only have to pay regular stamp duty rates - and will escape the 3% surcharge usually levied upon buy-to-let investors. However, if, at a later date, you end up buying a property to live in while hanging onto your buy-to-let property, you'll have to pay the surcharge.
Remortgaging for landlords
A raft of taxation changes - including cuts to mortgage interest tax relief and the 3% stamp duty surcharge for property investors - has resulted in many landlords deciding to refinance their portfolios rather than adding to them.
Indeed, data released by UK Finance in August 2018 showed that the number of landlords remortgaging had increased by 4.5% year-on-year. The current trend in the remortgaging market is that lenders are cutting up-front fees on their products as they look to entice landlords.