Plan for a larger deposit than a home buyer needs

Investment property financing facts

Property investment opportunities offer a range of benefits that other investments just can’t match. One of these, as we’ve discussed in a previous property investment blog, is the advantage of gearing – or borrowing to invest. Making money with other people’s money is perhaps the most efficient way to invest in property UK.

However, obtaining a buy-to-let mortgage has become more difficult in recent years. To take advantage of the best property investment opportunities, you’ll need to be prepared to put down a larger deposit than you would need to buy a home.

In this article, I examine buy-to-let mortgages, how they work, and how to plan for the unexpected. Armed with this information, you’ll have the knowledge needed to get the best loan to fund your investment property purchase.

What is a buy-to-let mortgage?

A buy-to-let mortgage is a type of loan specifically designed to enable property investment. In many ways (as we’ve explained in previous investment guides), they are similar to conventional mortgages. However, there are some fundamental differences. These include higher interest rates, higher fees, and the way the lender assesses the loan. It will take into account the probable rental income when making its decision whether or not to lend you the money.

What deposit do lenders require on a buy-to-let mortgage?

One of the key differences between normal residential mortgages and mortgages used to buy investment property is the size of deposit you’ll need to put down. Lenders consider property investment as a riskier proposition than lending to buy your own home. Because of this, you’ll need to plan for a larger deposit when considering property investment.

The average deposit required today is around 30%, and the larger the deposit you can pay the lower, the interest rate will probably be.

How much can you borrow to buy your investment property?

If you buy your own home, the amount that you can borrow will be linked to your income in some way. It’s similar when you buy an investment property. The amount the lender will extend on a buy-to-let mortgage will be linked to the rental income expected on the property. The lender will want a cushion: rental income that makes it comfortable with the loan.

Though different lenders have different rules, most lenders will require the rental income to be between a quarter and a third higher than the mortgage payment. It is one reason why the majority of property investors fund their property investment with interest only mortgage and not a repayment mortgage.

How to get a mortgage for property investment

Most high street banks will offer buy-to-let mortgages. There are also several specialist lenders that operate in this market.

Some people investing in property (especially first-timers) make the mistake of only using comparison websites to source their property investment finance. While these can be a good starting point, they don’t always show all the mortgages available, and you could end up with a worse rate or less favourable conditions.

Also, unlike homebuyers’ mortgages, the buy-to-let mortgage market is not regulated. You won’t be offered the same protection.

A mortgage broker with particular experience in the buy-to-let mortgage market will know all the current rules, lender criteria, and best offers. They will be able to discuss your personal situation and objectives for your property investment, and use this information to guide them when recommending a suitable mortgage product and lender for your investment.

Plan for tough times and take advantage of the good times

Don’t make the mistake of planning your financing too tight. No matter how good your tenant is, there are plenty of things that could go wrong.

For example, your tenant might lose their job or have their income affected by an overtime ban at work. Either way, their earnings will be affected, and this may affect their ability to pay rent. The rental deposit you took will mean little when a tenant doesn’t pay their rent for several months.

The tenant may decide to take a new job offer at the other end of the country, or perhaps to expand their family. They’ll be looking for a new home, and will be unlikely to tell you they are doing so. You could find yourself with an empty property for several weeks while you try to find a new and suitable tenant.

You can mitigate these void periods by:

  • Allowing for void periods when planning your cash flow
  • Saving some of the rent in a separate contingency account when rent is coming in as it should

To further protect your property investment, you should always be covered by landlords insurance (see below).

What if mortgage rates rise?

Mortgage rates are exceptionally low at the moment. They look like remaining so for at least another two years (though, of course, there are never any guarantees). When we work with clients, we make contingency for a rise in interest rates in cash flow planning.

By calculating your cash flow should interest rates rise by, say, 1% or 2%, you are again planning conservatively. You’ll be prepared for an increase, should it happen, and you will also have stashed some of your rental income away to cushion the blow.

If interest rates do rise, it might also consider passing the cost on to your tenant. After all, interest rates tend to be increased to combat inflation – and if prices are rising in general, then your tenant might be expecting you to increase their rent. One word of warning, though: don’t cut your nose off to spite your face. If raising the rent forces the tenant to move, you could be looking at a costly void period.

(There are some great tips in this property investment blog – 6 strategies to avoid the nightmare of buy-to-let rental disputes.)

Benefit from landlords insurance

The insurance you need on an investment property is different to the buildings and contents insurance you buy as a homeowner. You should have this cover too, but landlords insurance provides extra cover for:

  • Non-payment of rent
  • Damage caused by your tenant
  • Loss of earning or the costs to rehouse a tenant in the case of an insured event (for example, flooding that makes the property uninhabitable)
  • Your liability for accidents in the property that cause injury to your tenants

Now, it’s not a legal requirement to have landlords insurance (though some lenders do insist upon it), but I think you’d agree that to protect against the unexpected it’s a cost worth carrying. Think about it this way – you don’t have to insure your home and its contents, but you do. You don’t have to have private health insurance, but you might.

Landlords insurance is one of those costs that, hopefully, is a wasted cost. Because if it is, that means your property investment (and tenants) have performed exactly as you had hoped.

In the next part of this property investment blog series, I’ll examine how rental income from investment property varies and how you can plan for it. In the meantime, feel free to contact one of the team here at Gladfish on +44 (0)207 923 6100 to ask about investment property opportunities and our tried-and-trusted bank of independent mortgage brokers.

Live with passion

Brett Alegre-Wood

Brett Alegre-Wood
November 6, 2016

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