The difference on buy-to-let mortgage when making large deposits

Three reasons you may want to pay a larger deposit to invest in property

Whether you’re a beginner investor or someone who owns a portfolio of several properties, one of the most important decisions you’ll make is how to finance your investment. For most property investors, this is done with the help of a buy-to-let mortgage. In this article, I examine the question that many investors ask me: “Will a larger deposit guarantee me a lower interest rate?” The answer may surprise you.

Buy-to-let mortgages require larger deposits

The first thing you must be prepared for when you apply for a buy-to-let mortgage is the size of deposit that you’ll need. There are several reasons for this, including:

  • The lender’s attitude to risk – a larger deposit gives them a bigger cushion against the possibility that you may default
  • The PRA introduced new lending criteria for investors in 2016, meaning that lenders now ask for a higher interest coverage ratio (ICR)

You can read more about deposits for investing in our article “Why do you need a large deposit for a residential investment property?”.

Generally, you’ll need to have a deposit of a minimum of 30% of the property’s value to invest in buy-to-let property.

What if I put down a larger deposit than the minimum?

You might consider paying a larger deposit than the minimum needed by a lender. This could be a good strategy because there are three main benefits.

1.      A larger deposit makes you a more attractive borrower

The larger your deposit, the more attractive you become to a lender.

The lender looks upon you more favourably because the cushion you’re providing them is bigger. If you default on your mortgage and they need to repossess, they’ll have much more room to take a discount to market value when they sell. This should mean that they will sell sooner and recoup the money they advanced to you more easily.

2.      A larger deposit makes it easier to meet the ICR

Because you are borrowing less, your interest payments will be lower.

With lower mortgage interest payments, your cash flow increases. Lenders look upon higher cash flow favourably: the higher your cash flow, the less likely it is that your buy-to-let property will run into financial difficulties.

The lower mortgage payments also make it easier to meet the lender’s ICR criteria, which is usually that the rent covers the mortgage payments by 140%. For example:

  • If your mortgage payments are £700 per month, at an ICR of 140% your rental income must be at least £980 per month
  • If your mortgage payments are £640 per month, at an ICR of 140% your rental income can be as low as £840 per month

If you are investing for income and cash flow, then paying down a larger deposit should help you to achieve your investment goals.

3.      A larger deposit may get you a better buy-to-let mortgage deal

When you buy your own home, the general rule is that the larger deposit you pay, the lower the rate of interest you will be charged. This rule holds true for most buy-to-let mortgage deals, too, though you must read the fine print. The deal you are getting may not be cheaper in the long run.

For example, most buy-to-let mortgages are interest-only on a fixed term. The longer the fixed term, the higher the interest rate is likely to be.

There may also be high set-up charges and expensive early repayment penalties. The first will impact the amount you owe, and therefore the amount of your mortgage payments. The second could cost you dearly if you need to sell the property sooner than you plan.

Finally, not all buy-to-let mortgage lenders offer a lower interest rate to those who pay a larger deposit.

And that’s the kicker. Paying a larger deposit will not guarantee you a lower interest rate.

My advice is to always use a mortgage broker who is experienced in the buy-to-let market. They’ll know which lenders are offering the best deals, what conditions they attach to them, and they will be able to advise on terms such as length of fixed rates. They’ll be able to give you a full breakdown of the real costs of a mortgage deal, helping you to make the best decision for you. This should help you make a better investment and should ensure you invest with the best possible cash flow dynamics.

If you have a question about property investment, contact Gladfish today on +44 207 923 6100. We’ll be happy to help, and the answer to your question could help other investors just like you.

Live with passion and fun,

Brett Alegre-Wood

Brett Alegre-Wood
June 4, 2018

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