If you intend to let out your property to tenants, you will need to select a buy-to-let mortgage product. They work in a similar way to normal mortgage products, but there are some striking differences. Before you take the plunge and invest in a buy-to-let property, it is worth familiarising yourself with the key differences.
Buy-to-Let: The Key Differences
Fees on buy-to-let mortgages are often higher than traditional mortgages, and lenders will usually want a larger deposit up front, typically between 20% and 40% of the property’s value. Also, most buy-to-let mortgages are interest-only. This means that unlike most mortgages, where you pay off the capital of the loan as well as the interest over the life of the mortgage, at the end of an interest-only mortgage, you still have the capital of the loan to repay.
Many borrowers assume they will be able to sell the property at the end of the mortgage period to repay the capital. However, if house prices have fallen, there is no guarantee that you will receive the same amount you paid for the property. You will then have to come up with the difference to pay off the remaining capital on the mortgage.
Lenders also have more stringent eligibility criteria for buy-to-let mortgages. Statistically, borrowers are more likely to defect on a buy-to-let mortgage; therefore, it represents a higher risk for the lender than a traditional mortgage. For this reason, many lenders will not allow borrowers under 25 years old or those that have an annual income of less than £25,000 to take out a buy-to-let mortgage.
Unlike a traditional mortgage, which considers your income, personal pension, and benefits when calculating how much you can borrow, a buy-to-let mortgage uses rental income to make the calculation.
Typically, lenders will not approve the mortgage unless your rental income will be more than 125% of the monthly mortgage repayments. For example, if you will receive a monthly rental income of £750 on the property, a lender will not provide a mortgage with monthly repayments of more than £600. The lender will contract a surveyor to carry out a valuation and assess the rental value of the property before the mortgage is approved.
Buy-to-let investors are subject to different taxes than other homeowners. Firstly, stamp duty tax bands are higher on buy-to-let properties. They are typically 3% higher than residential purchases. Your rental income may also be subject to income tax, and when you sell the property, any profit you make will be subject to Capital Gains Tax.
With higher taxes and increased risks in buy-to-let mortgages, landlords must be financially secure and confident they can meet the repayment terms before agreeing to them.