When buying property to invest in, you can choose to use a buy-to-let mortgage to help you pay for the property.
Buy-to-let mortgages are quite different from regular residential mortgages, both in terms of the requirements for them and how they are repaid. Investors must understand these differences, so they are not investing under incorrect assumptions.
Given the increased risks of using property as an investment compared to living in it, lenders have higher standards when reviewing applicants for buy-to-let mortgages. These requirements differ from lender to lender, but generally fall under similar guidelines:
- Borrowers should be earning over £25,000 a year.
- There is normally a minimum age requirement which is usually 21 or over.
- Borrowers should already be homeowners.
- Having a healthy credit score.
- Having their financial situation in order, with no major unpaid debts.
Specific lenders may have their own additional requirements, but these are general guidelines you should aim toward if you choose to borrow a buy-to-let mortgage.
There are several other ways in which buy-to-let mortgages differ from residential mortgages, as you will normally be expected to pay a much larger deposit upfront compared to a regular mortgage.
Most buy-to-let mortgages have a deposit of anywhere from 15-25% of the property’s price. This is much higher than the usual 5% deposit of a residential mortgage and is reflective of the higher risk of investing.
The biggest difference between the two kinds of mortgages, however, is the fact that you can often leave the amount of money borrowed in a buy-to-let mortgage untouched during the term of the mortgage.
Instead, you make monthly repayments on the interest accrued from the mortgage. These interest-only payments are made using the rental income you collect from the property, as this gives you a monthly cash flow.
The interest rates are set at the beginning of the mortgage and are usually higher than residential mortgages, so the lender makes more of a profit from the repayments.
Buy-to-let interest rates are currently at high levels, with the average two year fixed rates hitting 3.41% in May. This was the highest level of interest seen in seven years, according to the Telegraph. Investors can expect to pay much more compared to recent years on their mortgage payments.
At the end of the mortgage term, you must repay the mortgage in full. This is usually a large amount of money, so many choose to either sell the property to pay the mortgage or refinance the property and continue the cycle.
If you choose to remortgage the property, then this will mean you consistently eat into your profits, so finding a way to pay off the mortgage is ideal for investors so you can earn higher returns over time.
Lenders will base how much they are willing to give based on the market value of the property and how much of a return you are expected to make by investing in it. This is known as a loan-to-value ratio, often shortened to the phrase LTV.
Lenders will want a lower LTV to ensure you can keep up with the mortgage repayments. This will likely cause a higher down payment, but this means the mortgage will be cheaper in the long run.
Therefore having a mortgage that is less than the property’s value is a good way of paying less over time, though it means a larger cost upfront.
Something important that you need to know is most buy-to-let mortgages are not regulated by the Financial Conduct Authority (FCA), which is why lenders often require more of a deposit.
Their money is at more risk than with residential mortgages, as if you default on the repayments their money is lost, so they want to protect their money more.