Unlocking the potential of buy-to-let property investment
In my last article, I explored the three common questions property investors ask about buy-to-let deposits. In this article, you’ll learn more about another crucial element of buy-to-let financing: the buy-to-let mortgage.
The buy-to-let mortgage
By investing in property using a mortgage, you get to take advantage of the benefits of leveraging in property investment. Using other people’s money (the mortgage lender’s) and investing for positive cash flow, you could massively increase the income return on your investment capital. Even if you invest with negative cash flow, using other people’s money could explode the percentage capital gain you make on your (currently) underperforming savings.
However, when you borrow to invest in property, you must use a buy-to-let mortgage. You cannot finance your investment with a run-of-the-mill residential mortgage. Here are the most common questions we are asked about buy-to-let mortgages.
1. Why can’t I use a residential mortgage to finance a property investment?
Lenders consider buying a property for investment riskier than buying a property as a home. This is because it won’t be you living in the property, and you are likely to rely on rental income to pay the mortgage. If you have a void period, your income dries up, and you’ll need to subsidise the mortgage from another source.
If you try to get around this rule and use a residential mortgage to buy an investment property, the mortgage lender could repossess your property.
2. What type of mortgage should I use – interest-only or repayment?
Most property investors use interest-only mortgages to invest. By doing so, your repayments will be cheaper and your cash flow more positive. You can also claim tax relief on mortgage interest payments.
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On the downside, if you need to sell the property and the value has fallen, you may find that you are short of the capital needed to repay the mortgage. If you are investing for the long-term like the majority of buy-to-let investors, this disadvantage should disappear – on average, UK property prices have doubled every seven to 10 years, and downturns in value are often short-lived.
Read more about the advantages and disadvantages of interest-only buy-to-let mortgages in my article, “Why savvy property investors use interest-only mortgages”.
3. How much will a buy-to-let mortgage cost me?
Generally, buy-to-let mortgages are more expensive than residential mortgages. However, the market is becoming more competitive and there are some tremendous deals available, at rates almost as low as residential mortgages.
Buy-to-let mortgages come in all shapes and sizes – some incur set-up fees, some will have early repayment charges, you can take advantage of fixed-rate deals, and so on.
4. Are there any special requirements to get a buy-to-let mortgage?
Two big differences between residential mortgages and buy-to-let mortgages are the deposit you need and the way in which affordability is calculated.
As discussed in my last article, you’ll need a larger deposit; usually 30% or more.
Additionally, the mortgage lender will want to see that the rent will cover the mortgage interest payments, and then some. This is calculated by the interest coverage ratio (ICR) – the amount of rent compared to mortgage interest payments and then expressed as a percentage. Most lenders will ask for an ICR of 140%, though some will accept 125%.
For example, if your rental income is £800 per month, your mortgage interest payments must be less than £572 per month (based on an ICR of 140%).
5. Where can I find the best mortgage deal to invest in property?
You are unlikely to find the best buy-to-let mortgage deal at a high street bank. The buy-to-let mortgage market is specialised, though it is growing rapidly. When I invest, one of my key investment partners is my mortgage broker. Mortgage brokers are in constant touch with the marketplace. They know which lenders want to lend, which offer the best rates, and which offer the right terms and conditions for my needs.
I could do this work myself, but it would take me days. By which time, the deals on offer may have changed. Quite frankly, I neither have the time nor the energy to waste on finding the best buy-to-let mortgage at any given time. My energy and time are better spent on finding great property investment opportunities, helping others, and enjoying my life and family.
One of my key pieces of advice to all property investors is to get the best mortgage by using a professional mortgage broker, experienced in the buy-to-let market, to do the donkey work for you.
In my next article, I’ll look at the most common questions asked about buy-to-let running costs.
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