Buy-to-let financing solutions explained
You want to invest in property. You want to change your life, and take advantage of the long-term benefits of buy-to-let investment. The potential rental income and increase in value could help you retire earlier and wealthier. There’s only one hurdle you need to negotiate: raising the capital to invest.
There are three occasions when you will need to raise capital:
- The deposit
- To complete a purchase
- To add to your property portfolio
In this article, we examine ways to raise capital for the deposit and introduce you to buy-to-let mortgages.
What are the buy-to-let mortgage rules?
Few property investors have the cash to invest in a buy-to-let property. Most use a mortgage to fund their investment. Buy-to-let mortgage rules are different from mortgages for main residencies. In 2017, the Prudential Regulation Authority (PRA) introduced several rules aimed at ensuring investors do not overstretch themselves financially. The main rules are that:
- A lender must assess your ability to afford the buy-to-let mortgage. It must base this assessment as if you are paying interest at a minimum of 5.5%, or 2% above your actual interest rate. So, if your mortgage rate is 3%, you’ll be assessed at 5.5%. If your mortgage rate is 4.5%, you’ll be assessed at 6.5%.
- Second, you must show that your rental income will cover your mortgage payments by at least 125%. Most lenders now use an interest rate cover of 140%.
In addition, you’ll need a deposit of at least 20% to purchase a buy-to-let property. Most lenders require a minimum of 30%.
What effect do these new rules have on buy-to-let property investors?
Let’s say you borrow £150,000 to invest in a buy-to-let property valued at £200,000, paying a £50,000 deposit. Let’s say your mortgage rate is 3%. The lender will assess you at 5.5%. It will consider that your mortgage payments on an interest-only buy-to-let mortgage are £688 per month.
Next, the lender applies the interest coverage ratio formula. Let’s say its rules state you need to cover of 140%. The minimum rental value of your property will need to be £963 per month. This equates to a rental yield of 6%.
Larger deposits make a big difference
You can combat the effect of the interest coverage ratio by paying a larger deposit. Here’s how this works, based on the above example:
Let’s say that instead of a £50,000 deposit, you pay an £80,000 deposit. Your notional mortgage interest payments reduce to £550 per month (£120,000 x 5.5%/12). The rental income needed to cover this is 140% of £550. This is £770 – a yield of only 4.62%.
How can you raise the amount for a buy-to-let deposit?
A 30% deposit is a big ask for many investors. However, there are several ways you can raise the cash to cover your buy-to-let deposit, legal fees and refurbishment costs (if any). Here is what you could do:
· Save
The obvious answer, though it can be difficult to achieve. It means giving up on some of your lifestyle choices while you are saving. It could take months or years if you are starting from zero. Planning your savings routine will help to reduce this time. If you are saving for a deposit, you should ensure that you do so in the most tax-efficient way (for example, use your ISA allowances).
· Remortgage
If your home has increased in value, you could remortgage. If the value has increased enough, you may be able to withdraw enough equity to pay the entire deposit. The amount you can take may also be limited by your income. If you remortgage your home, you should ensure that you can make the repayments.
· Use a further advance
If you don’t want to remortgage – for example, because your existing mortgage is on a great interest rate – you might consider a further advance from your existing lender. The interest rate is likely to be higher than your existing rate, and your property will need to be revalued.
· Buy-to-let equity loans
A relative newcomer to the methods you could use to raise funds, a buy-to-let equity loan lets you borrow money without making monthly repayments. You can borrow up to 20% of the property value, with a combined borrowing of no more than 85% of the loan to value. The term is usually 10 years, and the amount you repay will be linked to the increase in the value of the property.
· Access your pension
Are you 55? Do you have a pension plan? Now you can withdraw all or part of your pension pot. There are no longer restrictions on how you can use it. You could take 25% of your pension pot as tax-free cash, and use it to help fund your property investment. You should seek expert tax advice before doing this.
· Set up a joint venture or partnership
By teaming up with someone else, you could use their cash with your own. Split the profits according to the share of cash that each of you put into the venture. Be careful not to let the arrangement ruin a good relationship. If you use this strategy, make sure that you put everything in writing.
· Use your bonus
If you have been paid a bonus from work, instead of spending it on holidays and cars, invest in property. Make your bonus work for your future.
In summary
The lending rules for buy-to-let mortgages mean that you must pay a larger deposit than if you were buying your own home. But, as you can see, there are many ways to raise the deposit. As well as all the above, you may have received an inheritance or currently own an underperforming investment asset.
With a little creativity and determination, anyone can raise a deposit for an investment property. Many investors – first-timers and experienced – use a combination of strategies. Younger investors often call on the Bank of Mum and Dad, buying an investment property instead of a home.
Once you have raised the deposit, a buy-to-let mortgage will provide the funds to complete your investment. BTL mortgages have different rules to residential mortgages, with affordability based upon the rent you are likely to receive and a notional mortgage interest rate.
When raising capital, you should always take advice. Depending on which strategies you employ, you may need to take tax advice.
In our next article, we examine how remortgaging can help you grow your property portfolio. In the meantime, to discuss capital-raising strategies for property investment in more detail, contact Gladfish today at +44 207 923 6100.
Regards,
Charlie Caddick
