Financing rental property - obtaining a buy to let mortgage
Financing buy-to-let property is slightly different from obtaining a mortgage for your own home. Higher interest rates apply, and lenders are more stringent in their application criteria. This section provides a guide to how to get a buy-to-let mortgage, including:
- what types of property will banks lend money on?
- interest rates for buy-to-let mortgages
- fixed vs. variable-rate mortgages
- endowments and life insurance mortgages
- finding the best mortgage deal
- how much can I borrow?
Specific details the lender will want to know about you, when purchasing a rental property include:
Finally, some examples of costing:
Banks and Building Societies will typically lend money to individuals who wish to purchase buy-to-let property on leasehold flats (not above commercial premises) and freehold houses, terraces, houses and cottages. Some banks consider leasehold flats above commercial premises. Most banks also require at least some 55-60 years left on the leasehold agreement.
The banks would normally stipulate property to have assured short-hold tenancy agreements.
About half of banks will allow borrowing for Homes of Multi-Occupancy (HMO) – meaning homes that have different contracts for different rooms, as long as the contracts are assured short-hold tenancy agreements. Some banks will not lend on such homes with more than say 5 or 6 separate rooms. The lender may also require evidence that the property has the appropriate fire/environmental certificate for HMO and that the council is in agreement that the property is operated as an HMO (in any case, you will need to check this).
Almost all banks will not lend on property with DHSS tenants (e.g. tenants who claim unemployment and housing benefits). Some will only lend on multi-occupancy homes if they are filled with students – these students may have single assured short-hold tenancy agreements or one such agreement for the whole house (the former would normally be preferred).
It is very rare to find a bank that will lend money on homes with so called “sitting tenants” or tenants with assured tenancy agreements. These tenants have full rights to stay and the value of such property is normally reduced to say 75% of the normal market value. A purchaser may find a bank willing to lend money on such property, but the purchaser is likely to need to put down a 40-60% deposit.
Some investors are willing to purchase such property if they have a lot of cash, it is a very low price and the “sitting tenant(s)” are very elderly or a deal could be struck to facilitate them moving to another appropriate home. Others investors may be happy with the rental income and be prepared to keep the tenants indefinitely.
Some banks will lend on property with bedsits (HMO – with say 8 bedsits) but this might be at commercial rates, with a lending limit of 75% of the purchase price assuming a multiple of gross rental income of 150% of the annual mortgage payments (at commercial un-discounted rate).
Buy-to-let mortgage rates are typically 0.5 to 1% above the Standard Variable Rate (SVR) the bank offers to its customers – this additional amount is to pay for the perceived additional risk of lending to Landlords with rented residential property. The SVR is typically about 1% above the Bank of England (BOE) base rate. This rate is considerably cheaper than a commercial lending rate that is normally 1.25% to 1.75% above the SVR (e.g. 2.25 to 2.75% above the BOE base rate).
Almost all lenders will offer either variable rates (SVR) or fixed rates (fixed for certain periods). You can typically lock yourself into a variety of rates for 1-10 years. A common offering is a SVR with a 1 year discount to say 1.5% below the current SVR, with a “tie-in’ for 3 years – meaning a redemption penalty of say 6 months mortgage payments is payable if you change product before a period of 3 years passes.
This is a popular type of product because it means the first year is low cost, whilst you get the property stable with good tenants. After a year, the rate will go up to the SVR and after 3 years you have the option to cheaply re-mortgage with the same company or another. Some 80% of investors choose the SVR (rather than Fixed) – this is probably because the Fixed rate builds in an insurance/ cost premium and look a bit expensive to most investors compared to the SVR.
Some investors may also think interest rates will be lower than the “market” is predicting in future. Furthermore, many investors like to take advantage of discounted deals from re-mortgaging – since the UK financing market is competitive with many products, its often perceived to be better to keep options open rather than fix. Some banks also charge an administration fee for setting up a fixed rate product, and the fixed rate products normally have longer “tie-in” periods and sometimes larger redemption penalties if you were to change product. That said, they provide a predictable future cost and some people lock in to good low cost deals at the right time.
The most popular payment period is some 25 years – some people choose 30 years, but this is not possible with senior investors, since the money normally has to be paid back by the time the investor is some 60 years old. You will normally have the option to have part interest payment and part repayment. Most investors choose interest payments only, to keep their short term borrowing costs lower, and to get greater exposure to the property market (e.g. higher borrowing and more property).
The requirement to get such coverage these days is less than in the early 1990s – the performance of such funds has generally been below average, and most people avoid them unless they are required to sign up to such a product – probably as added security for the lending bank. The common complaint of such products has been the high commission paid for selling the product in the first place (in the early 1990s, this was sometimes equivalent to 4 years of payments). Objective advice can be sought on such products from a truly independent broker– but my steer is – be very careful. PropertyInvesting.Net advises to put capital funds into straight mortgage borrowing to purchase high growth and rental income investment property, rather than such products.
Many buy-to-let investors use mortgage brokers. These brokers do not get commission from the purchaser (they would instead typically get commission from the banks or building societies on completion of the product you accept – hence you will not normally pay for their services). The use of brokers is most common with less experienced investors, or investors that have a particularly tricky borrowing requirement needing help. Repeat / simple transactions may not require a brokers help, but many investors would still use a broker to save time.
I have used MortgageFind with great success for many of my purchases – they are independent and will find the most competitive borrowing to match an investor’s requirements (e.g. size of deposit, financial circumstances, employment status, gearing, rental multiples to asking price, renovation requirements). Tom Cleary is Director of MortgageFind (Tel 020 8303 9300, Fax 020 8298 1908), and can help you with the best current deals on offer by the UK banks and building societies.
Banks will normally look at the ratio of rental income to purchase price – they will ask that the gross annual rental income is at least 125% (easier lending criteria case) to 150% (tougher lending criteria case) of the annual mortgage costs (assuming Buy-to-Let non-discounted rate – e.g. some 0.5% to 1.5% above the SVR). This needs to be considered before putting an offer in on a buy-to-let purchase.
It is not a good experience to find that rather than getting 85% borrowing, because of the rental multiples, the bank will only lend you 75%. On a 100,000 pounds property you would have to find another 10,000 pounds, or turn the deal down (a time and money wasting experience).
It is therefore best to get an early estimate of the rental income potential from a reputable letting agent. You can then ask questions about the property concerned, with regard to its suitability as a rental investment, the local rental market and proximity to tenants / demand. If you are aggressively building a portfolio of properties, this simple mistake could lead you to buy only say 60% of the property that you wished to acquire because you are only able to borrow 75% rather than 85% of the purchase price.
At the bottom of the page is an example of financing a buy-to-let property, to show you the sort of calculations you need to make.
Many of the larger banks and building societies have good websites that have downloadable application forms and details of their lending criteria. To save time though and get access to all deals easily, I would suggest using a broker (e.g. MortgageFind).
Building societies and banks lend money for residential buy-to-let and fairly standard types of investment property purchases. Typically, Banks prefer to lend money to individuals, rather than companies, trusts or entities with either single of shared ownership. This is most likely because the banks and building societies find that with loans to individual, there is single point accountability, they can repossess property quickly if there is a payments default and individuals are less likely to go bankrupt compared to companies.
You will find it easiest to get a loan if you are an employee, preferably with a high salary in long-term employment. Self-employed people can get finance by completing a self assessment application – which is subject to verification from an accountant or other professional person. It is very difficult getting finance if you have no regular income, particularly if you do not have a large deposit for the purchase.
Buy-to-let mortgages can be obtained from most banks and building societies. They normally lend to a maximum of a least 75% with some banks going to 80%, with a small minority lending to 85% (e.g. Birmingham & Midshires, MortgageExpress). PropertyInvesting.Net is not aware of any banks willing to lend more than 85% of the purchase price on buy-to-let purchases. Some lenders will also give funds for renovation or upgrade depending on the circumstance. Other lenders may require the purchaser to front these additional funds on top of the deposit.
Many banks and building societies require your gross (before tax) income to be some 25,000-30,000 pounds before they are willing to lend on buy-to-let property. A few banks do not actively consider your income or employment – rather, they will look at the buy-to-let property economics on its own and consider your credit history and assets/ liabilities (contact MortgageFind for details).
Banks and building societies lending on commercial property (e.g. a large terrace house with ten bedsits) look favourably on borrowers who can demonstrate a good business case and have done a proper economic evaluation of the property, with risks and opportunities. Also, on normal / standard buy-to-let applications, a short write-up about the marketability of the property, rental demand and potential for capital value increases is probably worth inserting under additional comments - though the banks may not take much notice of it - rather they will look at their specific lending criteria and judge your application on those merits instead.
Always make sure you fill in your application objectively with appropriate integrity. Avoid using any optimistic numbers and make sure your application can be fully verified – the number one rule in successful business is integrity.
Costs of borrowing are typically about 275 pounds for administration and about 275 pounds for a survey/valuation. Most of the time, the lender will allow either the administration fee or the survey/valuation fee to be added onto the borrowed amount at completion – hence the cheapest flat may only have an up-front cost of some 250 pounds.
A Homebuyer’s Survey is additional – this is a fuller report of the property and normally costs about 500 pounds. Specialist surveys for specific issues such as a Structural Engineers Survey normally cost an additional 500+ pounds. Damp and wood-rot / beetle surveys and quotes for works required are normally free, though some companies charge between 50 and 150 pounds for such a survey/report.
On full commercial lending, typically up to 75% of the purchase price, the survey fees are higher at about 1100 pounds, and administration fees are also a bit higher at about 350 pounds – for this you will get a fuller Commercial Survey and valuation report, though this is not a full Building Survey.
For your reference, enclosed is a typical list of purchasing costs for a 1 bedroomed flat in SE England (purchase price - 100,000 pounds):
|Banking transfer fees||
|Stamp duty (1%)||
|Total (money in)||
* Additional risk taken because a Building Survey at 500 pounds is not commissioned. No major problems or issues with property (hence solicitors fees were kept to 550 pounds). The flat was not in a deprived area hence stamp duty was payable.
If rental income is 550 pounds/week (with 20% letting costs and 5% maintenance and service costs) and mortgage costs are 6.2%, then the property breaks even in the year. You would only get borrowing at 80% on such a property from a lender that has a multiple of 130% (or 125%). See also the letting section for details on economics of letting your property.