How do you apply for a buy to let mortgage? Who qualifies for a buy to let mortgage? And what should buy to let investors know when trying to get a mortgage?
We’ve invited Peter Catton, a financial advisor since 2006, to answer these questions and explain how you can prepare and apply for a buy to let mortgage. Peter specialises in mortgages, although he is qualified in all areas of financial advice.
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– How do investors qualify for a buy-to-let mortgage? What can they do to prepare?
To qualify for a buy to let an investor needs to save around 25% deposit ( a few lenders offer 20% options but they are very difficult to get). The criteria for a buy to let varies massively from one lender to another much more so than a residential mortgage. Some lenders have a minimum earned income to qualify whilst some will not have any income requirements at all. The most important factor in assessing whether a buy to let mortgage application will be successful is the rental income achievable in its current state. A lender will lend based on how much rent their surveyor thinks a property will achieve. Each lender has a fairly similar calculation. Which depends on the rate of income tax the investor pays (the lower the better so opposite to residential properties) and how long they fix the rate for. A lender will lend more money on a 5yr fix as opposed to a 2yr fixed rate. The biggest cause of a buy to let mortgage to fail is a rental shortfall which then means the investor has to put in a bigger deposit.
In terms of what an investor can do to prepare, look for properties that will create a good rental yield talk to the estate agent for advice in good rental areas where there is strong rental demand, often these will be in areas that demand a lower purchase price. On a buy to let credit score is very important more so than on a residential property, so they need to make sure they are on the electoral role and get a copy of their credit file to ensure there are no missed payments on anything it’s a good idea to make sure all debts are set up on a direct debit to ensure there are no late payments on any financial commitments.
– What advice would you give when deciding between an ‘interest-only’ mortgage or a ‘capital repayment’ mortgage?
My advice is on a buy to let to have an interest only mortgage. Lenders allow 10% of the balance overpayments per year, so just because a mortgage is on interest only does not mean you cannot pay it off quickly. Only the mortgage interest is offsetable for tax, so if a mortgage is on interest only it’s easier to work out how much interest you have paid. Also by having the lower payment of an interest only mortgage it gives you more facility to save up a rental emergency fund which can then be used in case the property needs repairs or you have a period where the property is not rented out. Once this fund gets to a satisfactory level you can then use the overpayment facility to pay off the mortgage.
Also on your residential mortgage the lender looks at your commitments, if a lender say you had rental income of £500 but you had a repayment mortgage of £500 then that would be treated as a commitment and would effect how much you can borrow on a residential mortgage. Had that mortgage been on interest only at say £200 and the investor was making an optional £300 overpayment so the same amount was coming off the mortgage each month. As they could cancel that £300 overpayment at any time the lender this would not be treated as a commitment.
– Would you recommend investing as a landlord through a limited company? What are the advantages and disadvantages?
This is a complex question and is all client specific, firstly whether you buy an investment property personally or through a limited company you are still liable for the additional rate stamp duty which currently applies to second property purchases, which is an additional 3% on top of the standard stamp duty. It is recommended that an investor speaks to an accountant or tax adviser to decide which is the favourable route. A lot will depend on how many properties they intend to buy over the longer term, there are costs in setting up a limited company and you need to file accounts each year at companies house, the taxation on rental profits fall under corporation tax as opposed to income tax so depending on their current income one may suit better.
In terms of the mortgage on these there are less lenders offering limited company buy to lets, the rates are higher and the fees tend to be higher which can offset some of the taxable benefits. So there is not a one size all fits answer I’m afraid so between the investor, mortgage adviser and tax adviser it’s worthwhile to have a discussion to weigh up the benefits of each option.
– There are several types of mortgages: fixed, tracker and variable. Can you briefly explain what each of these mean?
Fixed rates are where you fix a rate for a period of time usually 2, 3 or 5yrs although some lenders are introducing longer rates. It is the most popular option especially when Bank of England base rate is at a record low. A tracker rate is a rate that is linked to the Bank of England Base rate so for example if it was a tracker plus 2% the interest rate would currently be 2.1% as Bank of England Base rate is 0.1%, however if the Bank of England Base rate went to 0.5% the mortgage rate would increase to 2.5% where as had they been on a fixed rate their interest rate would not have changed during the fixed rate period.
Tracker rates are good if you believe interest rates will come down. A variable rate mortgage is on a lender’s variable rate, this is the least popular option as it’s usually a higher rate and you also have the least control if a bank decided to increase their variable rate your mortgage rate would also increase, a bank may decide to do this even if the Bank of England base rate has not moved.
– How can investors know which is right for them?
Again a discussion with an adviser to decide what the long term plan is usually is enough to decide on the best route, if it’s long term security you can’t beat a long term fix rate however they are not very flexible and can be expensive to get out of, so if you need more flexibility as you may want to increase borrowing in the future maybe to raise deposit for another buy to let or for home improvements then maybe a shorter fix or a more flexible variable rate might be the better option.
– Investors might be attracted to a particular mortgage because of its low fees and later find the process to be slow and arduous due to poor service. What are the main things investors need to lookout for when selecting their buy-to-let mortgage?
The fees should not affect the service. An adviser should know roughly how long a lender’s service timescales are as a lot of lenders now advertise that. If time is of the essence then it is important to tell the adviser that as it will form part of their recommendation. It’s also important not to get caught up in the chase for the lowest interest rate.
As an adviser we look at the lowest cost option rather than the lowest rate. Buy to let mortgage lenders will have many options on rates, some with very high fees in the thousands of pounds and some with no fees, so it’s important to consider the fee in relation to the amount you are borrowing and how long the rate lasts. If you are borrowing £100,000 on a rate for 2yrs and there is a £2000 arrangement fee then that is 1% fee per year, so it might well be worth looking at a fee free option the rate may be higher but may not be 1% higher and so a lower cost option.
It’s also worth looking at the incentives the lender is offering this may include a free mortgage valuation survey or a contribution to the legal fees. A good broker would consider all these factors not just be rate driven.
– Why is it important for investors to use a Financial Advisor when looking for the right buy-to-let mortgage?
Using a good adviser is likely to save you time and hopefully save you money. Some lenders will only take buy to let mortgages from advisers and so some deals would not be available direct. As an adviser we are paid by the bank, depending on the size of the mortgage and the level of work involved there may be a fee to pay. But the adviser should be able to tell you this straight away. We are able to run the rental calculations before an application and should know the lenders criteria to stop any wasted or unsuccessful applications which are very frustrating.
We do the application process on behalf of the client so are quick call away for questions or updates rather than being on hold to a banks call centre trying to find out why you haven’t heard anything on your application. It is more difficult to pick the right option than on a residential mortgage so we are here to make this easier.
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