Bad financing decisions put property investment underwater

It’s essential to get buy-to-let mortgage advice

Of all seven sins of beginner property investors, bad financing decisions are among the most common. Even if you’ve bought in the best places to invest in property UK, if you haven’t got the best mortgage then you won’t maximise your rental income profits or capital gains.

In this article, you’ll read the story of an investor who thought she’d got a great mortgage deal. It wasn’t until she met with a buy-to-let mortgage broker that she realised how much profit she’d lost, and what bad mortgage advice costs.

Prudence’s mortgage catastrophe

Prudence had been banking with the same bank since her mother opened her first savings account. Since before she even started school, every week she’d take a little bag of coppers into the nice man on the counter and deposit some of her pocket money. As she got older, the savings habit continued. When she got her first paper round, she continued to save half of everything she earned. She considered money received on birthdays and at Christmas as bonuses, and banked those, too.

The nice man on the counter grew older, got more experienced, and eventually became the manager at the bank. He’d watched Prudence grow, and had always done the right thing for her. It was only natural that when she wanted to buy a home with her fiancé, she went to the bank.

Their first home did so well, backed by a great fixed rate home buyers mortgage, which Prudence and her husband-to-be decided that their financial future could be more secure if Prudence invested in a property.

A mortgage to secure financial freedom

By this time, Prudence had saved more than £40,000 – enough for the deposit on a buy-to-let property. Her objective was simple. She planned to have children in around seven or eight years, and wanted to achieve two things:

  • Create an income that would help her to be a stay-at-home mum
  • Benefit from the growth on a property investment that would pay for her children’s university fees when the time came

Once she’d had children, Prudence planned to return to work at some time in the future, but didn’t envisage this until the children were in their teens, or perhaps even left home.

She explained her life plan to her bank manager, who thought it was an excellent idea. He told her that she would need a buy-to-let mortgage and that the bank could help her with this.

A wise property investment

Prudence found a property to buy, and with the aid of the bank’s buy-to-let mortgage she was able to afford the £160,000 purchase price.

The £120,000 mortgage was set with a flexible interest rate at 5.25%. The monthly payments were £525 per month. When added to other costs such as property management fees, landlord insurance (which was attached to the buy-to-let mortgage by the bank), and maintenance and repairs, her total costs came to around £725 per month.

That was about £50 more than her monthly rental income of £675, but she had been prepared for this negative cash flow. As the property increased in value, she expected to be able to increase the rent. Her ambition was for the property to make her a net income of around £400 per month when she had children in a few years.

Interest rate rise anxieties

For the first year or so, everything went according to plan. Then the Bank of England increased its base rate, and the mortgage payments on Prudence’s buy-to-let mortgage increased. A second rise in the interest rate was made a couple of months later. And a third soon after.

By now, the finances on her buy-to-let mortgage were beginning to take their toll. The negative cash flow of £50 per month had been acceptable for the potential capital gain. But in just two years, her mortgage payments had increased to £650 per month. She was now underwater each month by around £175.

Friendly advice that goes wrong

She spoke to the bank manager, who suggested she increase her rent to cover some of the higher mortgage costs. Working through her finances, she decided it was the best way to proceed and wrote to her tenants explaining that when the tenancy was renewed a couple of months later, their rent would be reviewed upward by £100 per month. Not enough to cover the whole monthly shortfall, but enough to make the negative cash flow manageable again.

Before the tenancy was renewed, Prudence was hit with another quarter-point rise in the Bank of England base rate. This time the bank increased its buy-to-let mortgage rate by 0.35%. The interest rate on Prudence’s property investment loan increased to 6.85%, and the mortgage payments to £685 per month.

Then the unthinkable happened. The tenants told Prudence that they would not be renewing their tenancy. They moved out. Prudence advertised the apartment for rent at the new price but didn’t get an enquiry. After two months and a £50 drop in rent, she managed to find new tenants.

Counting the costs

Now she was paying a mortgage of £685, and receiving the rent of £725. Once her other costs were taken into consideration, she still had to subsidise her investment property by almost £150 per month. Plus, the two-month void period had lost her more around £1,400 in rental income.

Worried that interest rates would increase again, Prudence went to see her bank manager. He suggested fixing the interest rate on her mortgage. It would mean an increase in the interest rate to 7.25%, but if interest rates rose during the next three years, her mortgage payments would remain unaffected.

She sat down with her now husband and worked through the sums. Perhaps she should sell the property? The problem was that the increasing interest rates had put a dampener on the property market. Prices were falling a little. She might be selling at exactly the wrong time.

There was only one thing for it. She would have to bite the bullet and fix the rate at 7.25% before interest rates went any higher. She resolved to call her bank manager the following afternoon to arrange to do the paperwork. It wasn’t his fault that interest rates were going up. He wasn’t the governor of the Bank of England.

Reality bites in property investment

At work the following day, Prudence got talking to a guy from another department who she had heard also had an investment property.

“I bet these interest rates are killing your cash flow, too,” she said.

“Not really,” Tom replied. “I meet with my mortgage broker every year. Two years ago, we decided rates were going up and so I fixed my mortgage for three years. I rolled it over to a new fixed rate last year. What rate did you say you were fixing at?”

“7.25%”

He whistled. “Woah. That’s a big number. I’m on five and three-quarters. And base rates are only 3.25%.”

“It is what it is, I suppose,” Prudence said, even more deflated.

Tom looked at her and pulled his phone out. He dialled a number, made an introduction, and handed the phone to Prudence. “Talk to this guy,” he said. “His name’s Adam. He’s my mortgage broker. See what he has to say.”

Two days later

“So,” said Adam, sitting across the desk from Prudence, “I can get you a fixed rate for three years of 6.25%. That will save you £100 per month on what your bank is proposing. Now, here’s the real interesting bit.” He handed a piece of paper to Prudence with two numbers written on it. He tapped the top one.

“By my calculations,” he said, “this is how much your bank has cost you during the last three years compared to the fixed rate I could have got you.”

Prudence stared in disbelief.

“Of course, that figure includes the lost rent you said that void period cost you.”

“Eight thousand, six hundred pounds!” she finally said.

“Yep, you’ve been paying 2% more – on average – than Tom has over the same period. And this figure here,” he tapped on the second number, “That’s how much paying 2% more than you have to on your buy-to-let mortgage would cost you over 25 years.”

“Sixty. Thousand. Pounds.” Prudence said slowly.

“It’s a good job you came to see me. Now, let’s get the finance in place that will help you get your kids to university when the time comes.”

The right mortgage product flows straight to your bottom line

Speaking to a mortgage broker with specialist buy-to-let expertise could save you thousands of pounds over the lifetime of your investment. Prudence’s experience was extreme, but by no means uncommon. Each 1% extra interest on your buy-to-let mortgage will cost you £83 per month per £100,000 of the mortgage. Over a 25-year investment period, that totals £24,600 per £100,000. What could you do with that extra profit?

Contact one of our team today on +44 (0)207 923 6100, and we’ll tell you how you can take advantage of an introduction to our select and expert buy-to-let mortgage brokers.

Live with passion

Brett Alegre-Wood

About the Author

Brett has over 20 years experience in all facets of property, he owns various companies centred around property and is the driving force behind the education and training at Gladfish. His companies have sold over £850 million in UK and London property and he manages over 1200 properties through his estate agency chain. Today he shares his time between UK, Australia and Singapore. He is married to Arlene and together they have 4 kids.

>