When unable to buy an investment property outright, a buy-to-let mortgage allows an investor to apply for a loan to purchase or refinance residential property. This property is then let out to tenants, rather than the buyer living in the property themselves, which provides the borrower with rental income. A buy-to-let mortgage has various differences to a standard residential loan. For example, rather than looking solely at the borrower’s salary, a lender will also look at the potential rental income of the property to scope the security of the loan. Although property investment through the use of buy-to=let mortgages are a very effective way of generating income, it must be sufficiently researched to avoid the associated risks.
Firstly, the borrower should research the type of property they are wanting to buy. The borrower should consider the current market and what properties are in demand so that the property can be let and at a higher price. Is there a demand for student housing, family homes, flats for young persons? Once the type of property has been established, the borrower then needs to consider the location he is to buy. If the borrower is aiming at students they will need a property that is relatively cheap to maintain as well as close to the university and nightlife, whereas families will want to be close to schools, parks, shops and perhaps have garden and storage space. Failure to consider what the targeted tenant will be looking for in a rental property may result in the property being hard to let. Ideally, buying in an area that the borrower is familiar with or close to home will is a safe option as this will reduce the risk, however where this is not possible it may be useful to use a letting agent in helping to manage the property.
Secondly, it is vital to ensure that the rent earned on the property will be sufficient to cover repayments. This is important when applying for a loan as lenders do not necessarily look at yearly earnings, but rather how much rent can be charged. Therefore, it is necessary to calculate the potential return on the investment by calculating what is known as the yield. This is simply the annual rent earned divided by the property value expressed as a percentage. For example, a house worth £100,000 with annual rent of £8000 would have a yield of 8%. However, this is not the gross yield. It is also important to not forget about the costs of maintaining the property, such as mortgage repayments, letting agents’ fees, building insurance premiums, and any general running costs. For example, say these costs total £4000 this then leaves a total profit of £4000 and a net yield of 4%. Further to this, the net yield may be subject to income tax and it is also necessary to take into account any further emergency payments that may be required.
Once a suitable property has been found which will earn a sufficient yield, it is then time to secure the necessary mortgage to buy it. In order to secure a loan, the borrower must be pass the criteria. As mentioned, the mortgage lender applies a rent to interest cover calculation. This means that the borrower must be able to prove they can obtain enough rental income from the tenant to cover the interest on the mortgage. Lenders will typically look for this rental income to be at least 125% of the monthly interest payments on the loan. A sizeable proportion of lenders also require a minimum income of £25k per annum in addition to the income earned from rent. In addition to this, a deposit is also required just like any other residential loans. Currently, it will be hard to find a required deposit of less than 25% of the purchase price, which is sizeably more than residential loans. However, lenders argue that buy-to-let loans are riskier therefore a higher charge is needed. It is common that a buy-to-let loan will have 1-2% higher rates than a residential loan.
After considering the above it is then important to gain appropriate professional advice…
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