What is a Buy to Let Mortgage? Mortgage Advice for Budding Landlords

Malcolm

My name is Malcolm and I'm joined by my colleague Wayne, and today we're going to be talking about buy to let mortgages. Buy to let has always been there, but I remember it really taking off in the mid '90s.

Wayne

I remember when it wasn't that common, but you're right, after the de-regulation of the building societies and the banks starting to become freer to lend in more areas, it became much more popular and banks began to compete against each other.

Malcolm

So, I suppose if you went back further than that, this would've been the domain of the professional Landlord that would do this for a living?

Wayne

Yeah, and the more commercial lending type banks would maybe finance it. But then, as the market freed up a little bit, you started to get the Landlords who didn't see this as their only living, as opposed to previously where you would have had professional Landlords and that was their business.

Malcolm

Do you think this has to do with people losing faith in things like pensions and other investments? Whereas property tends to be something that they know and they understand?

Wayne

I think there's definitely an element of that. There was a lot of bad press about pensions. Historically, your employer would often contribute a large chunk of your pension contributions, though that started to disappear.

People were having to fund their own, make their own arrangements. Property prices can go up and down, but the general curve is upwards.

Malcolm

I suppose some of these people that were getting into this in the '90s and early 2000s might have been people that have benefited from seeing properties that they already own go up in value.

Wayne

Especially if you've lived through that period where you've seen be a couple of property price booms. All of a sudden, the value in your house is going up by 50%, 60%, sometimes double. Then you might think that's then going to be a good investment for your future.

Malcolm

Typically, lenders will want you to put down a higher deposit for buy to let than they would do for a residential.

I think the reason behind that really is that if you fell into some financial difficulties, and you had to decide between paying the mortgage on your own residential property, as well as losing your tenant at the same time, you'd probably prioritize paying your own mortgage.

The banks want to minimize their risk by looking for a higher deposit to come down. Now the amount of deposit on these depends on what's happening with the market.

Wayne

I say you would typically be safe with a 25% deposit. There have been times when lenders will do it with a 20% deposit and when the market was booming, we even saw 15% deposits. I think if you worked to a 25% deposit, you will more often than not, be in with a good chance.

Malcolm

We often have customer come to us asking about first time buyer buy to let mortgages, probably homeowners looking to supplement their income or look for an investment for the future by building a property portfolio.

How do people do that?

Wayne

First of all, a lot of the people who have seen that property growth in the value of their own home, they've got latent equity in their own home.

So often people will look to release some capital from their own home in order to fund the deposit of their next purchase.

Malcolm

I have had an offset mortgage before. So, you can draw that money down as and when you need it?

Wayne

Yes, that’s correct. So that's often a starting point for people looking to get onto the Landlord market for the first time.

Malcolm

So, they've released this money out of their own residential property. They could maybe perhaps go and buy one with the cash, or could they spread that?

Wayne

Spread it and buy two or three. The key to success is always going to be, what sort of return are you going to get on your capital?

So, for example, it might be worth using that lump sum, to buy maybe two or three houses. They might not be the most valuable houses, but they might be in very good rental areas, for example, near to a university where students often rent.

That actually then gives you a very good return on the capital investment that you've made.

Malcolm

So, you mentioned universities. These would be house of multiple occupation, HMO's as known in the industry. They would normally attract a high yield, a high monthly rental amount?

Wayne

Yes, they would. Obviously with the laws, there are more regulations that come from it because they have to be registered with the local authority. Because of this, lenders do tend to treat them as a slightly different category. There is however, the chance for high reward.

If you've got a house with, say four bedrooms in it, and four students with a room each, each paying their own rent, that could generate more than if you just let to a single family who were renting the whole house.

Malcolm

So, through the 2000s, buy to let really became very popular. Lots of people, dinner party Landlords. This would be people talking about the values of their investments going up and the yields, etc.

But the number of first time buyers was going down, which is not a great thing. The government, in 2015, decided to try and do a bit of social engineering to change this, to make it less advantageous for Landlords to carry on buying.

How did they go about doing that, Wayne?

Wayne

Well, basically they changed the tax situation. So, over a period of four or five years from 2015 onwards, 2015, 2016, whichever, they phased in a series of tax changes to the way that the rental income was taxed.

Malcolm

So, prior to that, you could offset all of your mortgage interest against your tax bill. So, if you've got your rent coming in, you could knock off your mortgage interest, plus other fees associated with Landlords.

Wayne

Yes, management, agent fees, things like that.

Malcolm

Your tax liability would be in some cases, next to zero.

Wayne

Yeah. You would pay tax on your net profit after you've deducted all the expenses. The change that was phased in is that basically, now you pay a tax on the gross rent.

We would always recommend that you take specialist tax advice before you launch into this.

Malcolm

Yeah. So obviously income and then your tax bill is calculated.

Wayne

There's specific allowance for Landlords. It's the same allowance basically for everybody. So irrespective of what rate of tax you pay, you pay on the gross rent, and you get the same allowance.

Malcolm

And because it was phased in, it almost came as a bit of a surprise to some of these Landlords.

Wayne

Yeah, exactly. I think a few people, it came in by stealth almost, and they didn't realize until at the end of it, when they then start getting quite a big tax bill at the end of the year on it.

Malcolm

The other thing was they introduced a stamp duty surcharge. Tell us a bit about that?

Wayne

If you are buying a property and you start the transaction, let's say owning one property, and you ended the transaction owning two properties, you would pay an extra 3% stamp duty over and above any regular stamp duty payment that would be made. That would be 3% on the whole price of the property.

Malcolm

So, if you too a £100,000 property where typically no stamp duty would be payable, you then pay £3000 that you weren't expecting.

Wayne

Correct.

Malcolm

It really didn't put Landlords off too much though, because history suggests that that property will go up in value more than 3000 pounds if you hold on to it long enough.

Wayne

Exactly, if you keep it long enough. It's also a cost that Landlords would factor into when they calculate what rent they're going to charge.

Now, obviously there's different things to factor into that, but certainly, it's an extra cost that they would factor in as to what the likely rent would need to be.

Malcolm

Some Landlords were put off by that surcharge and they continue to be so. As such, the portion of first time buyers has increased. So, it was a bit of social engineering that possibly did work in the favour of first time Buyers.

Another question that we get asked regularly, and it's really one for a property specialist tax advisor, is should a client start up a limited company?

What kind of advice do you give to customers who were thinking about doing it that way?

Wayne

It comes down to the taxation angle and you need to speak to a specialist. It will be different for every single person, depending on different factors.

For example, if you're a higher rate tax payer already, or will the rent push you into being a higher-rate tax payer?

I think the key considerations are, first of all, from a lending perspective, it's fair to say that that fewer lenders actively participate in the limited company arena. I should say, by the way, it needs to be what's known as a specialist purpose vehicle.

Malcolm

That's right. So, that means that the limited company that you start up can only be doing property.

Wayne

Correct. So, if you've already got your plumbing company, and you're a limited company as a plumber, you can't just buy the properties within your plumbing company. You have to set up a separate company and ring fence it.

So, it needs to be a specific company. Fewer lenders lend in that space, so you'll have less choice. Generally speaking, because the lenders see that as potentially higher risk to them, you're less likely to worry about keeping up your payments if you don't even own that property, it's your company that owns it.

The rates that they would charge would be higher to the limited company than it would be if you were just buying it as an individual. In a lot of cases, all of those disadvantages could be outweighed by the fact that you can take your income possibly as dividend income from your company and that's taxed differently.

Now, it's different for everybody, you need the specialist advice, but for a lot of people, that can then prove much more beneficial than the disadvantages of paying slightly higher rates or having slightly less choice of lender.

Malcolm

So that might be like a tradesperson who thinks "I'm on the tools now. But when I get into my fifties and sixties, I don't want to necessarily be doing that."

Wayne

Correct. That's their priority. Other people may choose to sell and generate the capital, having that available as a pseudo-pension fund when it comes to retirement down the line.

Malcolm

People that want to generate some instant income might do an interest only mortgage?

Wayne

Yeah. That is a big difference between say the buy to let market and the residential market, where interest only mortgages are much more commonplace.

If you're only paying interest on your loan and you're collecting the rent, the gap between what your revenue coming in and your outgoings going out is much bigger. It gives you more income.

Malcolm

Yeah. Perhaps if you were looking at something more for the future, you could go on repayment buy to let mortgages?

Wayne

Exactly. Because the rent that comes in is paying off the mortgage for me. And I'm not really bothered about any extra income that it generates now.

But in 20, 25 years’ time, if I've then paid that mortgage, if I sell that house, I get the full value of that house to do with what I wish at that point.

Malcolm

We get a surprising number of inquiries from first time buyer, first time Landlords, don't we? Which might surprise some people.

Why would you buy a property for investment before you've bought a home for yourself to live in?

Wayne

I guess there are possibly some occupations, maybe if you're in the armed forces and you're moving around, but you like the idea of buying somewhere for your future. From a lender perspective, clearly lenders typically want to see some sort of experience that you've been used to paying the mortgage.

So, whilst I'm not saying you can't do it, because there are lenders that will do it, it depends on the lender. Not all of them will do that because they would see a first time buyer, first time Landlord, as a bigger risk.

Malcolm

The reason that it is potentially a bigger risk, is that it could be a way that customer could take out a bigger mortgage. Because it's not so much based on how much you're earning, it's more like the rental income that's coming in.

Does the rental income that's coming in exceed the mortgage payment by certain percentage, like 125%, 145%? Lenders are nervous about these backdoor residential ones. So, for example, you live in London but you're buying property in Leeds, then that might work in your favour.

Wayne

They don't think that you're going to live there. Whereas if you're buying one two doors down from your mum's house, and you're going to carry on living at your mum's house and let that one, they're probably going to be a bit more sceptical.

Malcolm

It's a very good point, people do stay at home for longer, don't they? Especially if they've got a nice, comfortable life at home and getting all their teas cooked and their washing done.

That being said, if they've got some money in the bank to invest and their family's had good experience with property, then that's how the first time buyer, first time Landlord market can develop.

Malcolm

What about the maximum number of properties? So, we’ve bought property and we've maybe started the SPV, limited company.

Do different lenders have different rules about how many Buy to lets you can have?

Wayne

Yeah, very much so and it varies quite widely. We've got customers, who've got 15, 20 properties, but not all with the same lender because some of those lenders will only, for example, lend on maybe two or three properties, some four or five.

It varies from lender to lender and that's where your advisor comes in. We'll look at your whole portfolio and the total value. We'll look at the total loan to value right across the range, because the larger your portfolio gets, lenders start to look at that.

They might be a bit more wary about lending higher loans-to-value if you've got everything at a higher loan to value already.

So, that's where your dedicated mortgage advisor comes in. We would do that research for you and make sure that the lender that has been recommended is one that is actually open to you and your portfolio, which is just down to that individual lender's risk profile.

Malcolm

So, what about buying properties and refurbishing them, and then releasing capital then to continue to build your portfolio?

Wayne

There are a few general things, a lot of lenders, they're a bit wary of buy to let remortgage property that you've just bought at a low value and remortgaging that straight away at a higher value, sometimes they're a little bit wary of that.

So very often it would need to be a six-month gap between you buying it and then refinancing it. Even then, not every lender does that and it really depends on the circumstances, but it's certainly a possibility.

Malcolm

So, if you took some before and after pictures and kept your receipts and invoices and things, that might go in your favour?

Wayne

Exactly, yeah.

Malcolm

Okay. Then just finally, on regulation. For some reason, buy to let mortgages always fall outside of the normal mortgage regulations.

Here at UK Moneyman, we treat every customer the same, the service is seamless. Whether you come into us for a residential or a buy to let mortgage, we're going to end up making it a recommendation.

There are a couple of exceptions where buy to let can become regulated and that's consumer buy to let and then when you're renting to buy.

Wayne

Yeah. As you said, consumer buy to let is typically where you are letting a property that you have previously lived in.

Malcolm

Many people identify a house on Rightmove they want to buy and they haven't really thought about selling their house yet.

Wayne

Yes, exactly. They might be in good jobs, plenty of savings, have got a deposit to buy the next house without necessarily having to sell their existing one.

Malcolm

The residential mortgage that we arrange for that is a let to buy. So, you've heard of buy to let, this is let to buy. We don't do as much of that now, because if the stamp duty surcharge, it really put some people off. Regulated is where you're renting to a son or a daughter, or a family member.

Wayne

I think people often think they can just buy it for their family member and it will be all nice and informal. Well unfortunately, no it won't be. Far fewer lenders will lend in that scenario, where it's a regulated Buy to let.

I guess what they are looking at is if you're letting your son or daughter live in your house and they’re going to pay the rent, and let's say your son or daughter then doesn't pay the rent, you're not going to kick them out are you?

The lenders see that as an extra risk. Those loans are probably going to be more prone to potential for arrears or ultimately, maybe possession. As such, they can be very difficult to mortgage.

Malcolm

Buy to let is a complex topic. Of course, we'll be delighted to help you with any questions that you have on buy to let Mortgages, so get in touch if you’d like to learn more.