Three steps to perfect property investment finance
Property investment is still the best investment asset in the UK. Historically, house price growth and rental yields have even beaten the stock market. The increase in the UK’s average house price between 1999 and 2016 was around 230%. The stock market fell during that period. (See our top 4 tips to make the best property investment decisions for more info about that.)
If you’re reading this article, you don’t need me to tell you that property investors are among the wealthiest people in the UK. Like many beginner investors, you want to benefit from all the advantages of property investment, but you’re not sure if you have enough money to get started.
In this article, you’ll learn how to work out how much capital you need to get on the buy-to-let investment ladder.
The three things you need to know to work out how much money you need for buy-to-let
To make a basic calculation of how much money you need for that first buy-to-let property investment, there are three things you need to know. With this knowledge, it’s then a question of doing a simple calculation.
1. How much does the property cost?
It is the first and most obvious element you need to know. Investment property prices have been rising strongly since the Global Financial Crisis. Although the rate of growth has slowed in the last few months, house prices in January 2017 are up by 4.3% from a year earlier – that’s nearly three times the rate of inflation.
House price growth over the long term is dictated by supply and demand, and in the UK we’re building somewhere between 50,000 and 100,000 too few houses every year. Households in the private rented sector are expected to rise from under 6 million today to around 7.2 million in 2025. That’s phenomenal growth, which could produce a phenomenal profit. No wonder you want to invest.
Investment property prices vary widely across the country. If you’re investing in London, you probably won’t get much change from £600,000 for the average apartment – though, as, in any other town, the price will depend on the property’s exact location. If you travel north to Hull, the typical apartment will cost around £80,000. Before you hold your head in your hands and despair at never having enough money to get started in property, don’t forget that you will be borrowing money to invest. The benefits of leveraging in property investment mean that you get to make money on other people’s money. To buy a £400,000 apartment in London, you don’t need £400,000 stashed away in your bank account. How much you can borrow depends on some things, predominantly how much rent your tenants will pay you.
2. How much rent will your investment property earn?
When a lender considers whether to give you a buy-to-let mortgage, it will need to know how much rent you’re likely to receive from tenants.
A lender wants to make sure that you’ll always be able to pay the mortgage. By calculating what is called the ‘interest cover ratio’ (ICR), the lender allows for things like void periods, when you don’t have rent coming in. (Actually, this concept – being conservative – is not too much different to how you would work out your cash flow when assessing which property investment opportunities are viable for you.)
Some regulations dictate what ICR a lender must use, but most lenders want rental of around 140% of mortgage interest payments.
3. The buy-to-let mortgage deal
Now we get to the nitty-gritty: the mortgage deal itself. There are several factors you’ll want to consider here. These include fees if the rate is fixed (and if so, for how long), and, perhaps the most important of all, the minimum deposit needed.
The Post Office has just launched a new line of buy-to-let mortgages. It’s three-year fixed rate at 2.67% is available to borrowers with as little as 25%.
However, don’t forget that the lender still has to calculate based on its ICR requirement, and at a minimum of 5.5%.
Property investment financing – an annoying complication
There is one complication that has recently been introduced: the lenders have to work out what mortgage payments you can afford based on an interest rate of 5.5% or 2% above the mortgage rate you’re paying, whichever is the greater.
So, if the rent you receive is, say, £1,000 per month, and the mortgage interest rate is 3%, and the ICR is 140%, you’ll be able to fund your purchase with mortgage interest payments of no more than:
= £1,000/ (140 x 100) = £714 per month = £8,568 per year
Calculated at an interest rate of 5.5%, your £8,568 in annual buy-to-let mortgage interest will buy you a mortgage amount of £155,782 ((£8,568/5.5) x 100)).
(Of course, your actual mortgage payments on this mortgage will be £155,782 x 3% = £4,673 per year = £389 per month.)
So, how does the Post Office buy-to-let mortgage stack up? Could you invest in a property worth, say, £200,000 with just a £50,000 deposit?
A £150,000 buy-to-let mortgage would cost you a notional £8,250 per year. If the ICR is 140%, you’ll be able to borrow £150,000 providing the rental income is £11,550 per year (£963 per month) – or, to put it another way, a rental yield of 5.78%.
In this example, if your actual mortgage costs are £4,005 per year (£334 per month) then you’ll be clearing more than £600 per month from your investment property before other costs.
In brief, the lower the rent, the higher the deposit you’ll need to find, irrespective of the lender’s loan-to-value ratio.
Want to know how little you need to start investing in property?
Contact one of our team today on +44 (0)207 923 6100, and ask about how off-plan property investment opportunities could help you get started in property investment way quicker than you thought possible. We’ll also be able to recommend a buy-to-let mortgage broker who will make sure that you get the best financing deal to meet your objectives and your start-up capital.