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Buy to Let Mortgage Guide

For homeowners looking to move up the housing ladder, becoming a property landlord is the next, natural progression.

This guide will give you an overview of Buy to Let Mortgages and how they work.  

Please Note: The information presented in this article is for research purposes only and is subject to changing legislation. Please seek independent financial advice if you would like to explore the legalities and taxation of Buy to Let mortgages, in more detail.

What is a Buy to Let Mortgage?

A Buy to Let mortgage is taken out on a property you do not wish to live in. These mortgages differ greatly from residential mortgages, because a profit is generated from rent. Therefore, this aspect needs to be factored into the mortgage agreement.  

What Types of Buy to Let Mortgages are Available?

As well as the conventional Business Buy to Let Mortgage deals, there are also Consumer Buy to Let Mortgages. These were introduced in April 2016, and are very much like ‘Let to Buy’ mortgages. This is where you let out your property and your tenants cover your mortgage payments. You can then use the rental income saved to put a deposit on a new home.  These are designed for people who are not using Buy to Let for business purposes, they may have fallen into being a landlord by living in a home they are struggling to sell or, for whatever reason, do not wish to sell.  

Am I Eligible for a Buy to Let Mortgage?

• You will very likely have to already be a homeowner to apply for a Buy to Let mortgage.
• You will need around 25% deposit for a property, as most deals have a maximum of 75% Loan to Value.
• You will need to pass a lender’s credit and affordability check. But please note, the amount you can borrow is not determined by your income (like with residential mortgages). The minimum income bracket for applying for a buy to let mortgage is typically around £25,000 pa, as this should cover your mortgage costs if there was ever a time when you have no tenants living in the property. Further, your income will be ‘stress tested’ for interest rates of up to 5.5% and you will also be tested to see if you could pay your taxes using just your personal income.

How is Rent Calculated?

Rental calculations are crucial to this type of mortgage plan, as it will determine the maximum amount you can borrow within a single loan. This top figure for borrowing is typically based on rental income (this could be, for example, 125%). This means that you should charge 25% more than your expected monthly mortgage charge. The interest rate charged on top of that may be around 5%. 

Please note: The maximum amount for borrowing is also determined on the amount of deposit you have available at purchase.

How is a Buy to Let Mortgage Repaid?

You will be responsible for collecting the monthly rent from your tenants and forwarding the funds to make your mortgage payments. Many buy to let mortgages are interest only, however other types such as fixed rate and tracker mortgages are also available. See our Guide to Mortgage Types for more information on how these mortgages are repaid.

What Buy to Let Insurance Policies are Needed?

This is also known as ‘landlord insurance’ and is essential for all Buy to Let investors. There are three main types;

• Buildings Insurance- This is a legal requirement for all Buy to Let mortgage holders. It is designed to cover damages to the property.
• Contents Insurance – This covers all interior fixtures, not just furniture. Even if you choose to let out an unfurnished property, this insurance will cover things like carpets and white goods.
• Landlord Liability – If you are renting to students, your lender may insist that you take out this kind of insurance, to protect your tenants in the event of injury.  

How Much Rental Income Tax Will I Pay on a Buy to Let Property?

The money you make from rent will be taxed at your relevant income band. For basic tax rate payers, this is 20%, for higher rate payers this moves up to 40% and for additional rates, this increases to 45%.

It is possible to deduct a number of allowable expenses from your tax bill, your accountant can offer an exact figure, as there are many variants, and further changes are being introduced by 2020. However, as a brief illustration, deductions may include;

• A certain amount of interest paid on buy to let mortgages and other related financial charges
• Council tax and ground rents
• Insurance premiums
• Repairs carried out within your property portfolio (pre-April 2016, landlords could deduct 10% for general ‘wear and tear’, this is no longer possible).
• Letting agent fees
• Solicitor fees 

How is Capital Gains Tax Charged on Buy to Let Properties

This tax is payable on the sale of a buy to let property. If the home has increased in value, capital gains tax may be charged on the value of the increase (minus stamp duty, estate agent and solicitors fees). The maximum allowance, per year, on capital gains without charge is £11,100 and this is separate to personal income tax allowance. The rate of tax charged varies and will be either 18% of the profit or 28% (based on your tax band).

Please note: At the time of writing, from 2019, capital gains tax will need to be paid within one month of property sale completion.

How is Stamp Duty Charged on Buy to Let Properties?

Buy to let homes will be charged an extra 3% on top of their stamp duty band, for every ‘additional’ property purchase over £40,000.  This will need to be paid within 30 days of sale completion. A breakdown of the tax bands are as follows;

• 3% on property sales of £125,000
• 5% on property sales of £125,000- £250,000
• 8% on property sales of £250,000- £925,000
• 13% on properties sales of £925,000 - £1.5million
• 15% on properties sales over £1.5million

Please note: Stamp duty is deductible from capital gains tax, payable upon sale completion of a buy to let property.

How is Inheritance Tax Charged on Buy to Let Properties?

Inheritance tax applies to buy to let properties and the amount charged varies according to your individual circumstances. An independent financial expert can help you calculate your inheritance tax, but at an overview level, if you are a sole landlord with a combined estate worth more than £325,000, inheritance tax may be payable. If you are married, then this doubles to £650,000. Anything over this figure is taxed at 40%.

Let’s Look at A Buy to Let Example

Tracy earns £60,000 pa and has been a landlord for 10 years. In 2016, Tracy got news that her taxation costs will be altered considerably and now she is reassessing her buy to let investments.

Previously Tracy made a rental income of £10,000 a year. Her mortgage interest was £9,000, giving her a £1,000 profit. As she is a higher rate tax-payer, she paid 40% tax on her profits (so, £400).

Under the new rules, Tracy’s tax relief will be capped at 20%. This means Tracy will have to pay tax on 40% of the £10,000 rental income, which is £4,000, minus 20% of £9,000 interest (which is £1,800). This will make her new tax bill £1,800.

What are the Benefits of a Buy to Let Mortgage?

• Multiple Properties – You can take out many buy to let mortgages and expand your property portfolio as much as you like. All that is required is that you have a residential property of your own, to start you off. Please note, a few lenders may impose a maximum limit on the number of Buy to Let mortgages you can take out with their company (for example, a maximum of three running at any one time, or a maximum of £1 million borrowed through them).  
• Interest Only – Interest Only Buy to Let mortgages are common and popular with landlords because they increase cashflow. For landlords who are just starting off, they may need funds to make repairs or redecorate, before their tenants can move in.
• Joint Buy to Let – If you are struggling to raise a 25% for a Buy to Let property, many lenders will accept joint applicants.

What are the Pitfalls of a Buy to Let Mortgage?

• Not for First-Time Buyers – Unfortunately, as is the case with the overwhelming majority of lenders, Buy to Let mortgages are not available to first-time buyers. In the very rare cases where first-time buyers are accepted, there will be high minimum income requirements.  
• Higher Interest – As there is the risk posed to lenders of tenants skipping rent (and therefore your mortgage repayments) the interest on these loans tend to be higher.
• You Can’t Live There – You are not permitted to take up residence in your buy to let property, this is mortgage fraud. If this is discovered before the mortgage is finalised, the funds will not be released. If you’re discovered after the mortgage completion date, your lender reserves the right to call in the mortgage loan.
• Less Choice – There are fewer buy to let mortgages on the market. This is to be expected, as there will always be a lower percentage of landlords nationwide.
• Higher Arrangement Fees – As these mortgages are tied to profits, the costs of applying are usually higher than with residential mortgages. Take a look at our Guide to Applying for your First Mortgage for more on arrangement fees and extra mortgage costs.
• Stamp Duty – When taking out a Buy to Let mortgage, from April 2016, you will be charged higher rates on stamp duty (3% higher) than those purchasing residential properties. 
• Capital Gains Tax – You will be charged tax on the income generated by rent and by April 2018, landlords will have to file their tax returns on a quarterly basis.
• Legal Landlord Requirements – You must conduct regular safety checks and adhere to UK landlord legislation, take a look at our Landlord Tips Guide for more on their responsibilities.

How do Joint Buy to Let Mortgages Work?

With joint buy to let properties, all parties must be fully aware of the legal implications and be agreed on their share of the mortgage, as well as their preferred timeframe for the venture.

The process of application is the same as a single buy to let mortgage application, in that your personal and rental income will be assessed carefully, as well as your credit ratings. Where these applications differ is in the split of the shares. As with joint mortgages, ownership can be split in one of two ways;

• Tenants in Common – This is where one party can claim a higher share of ownership of the mortgage (for example 60/40 split), when the property is sold. Under this agreement, another named beneficiary can be included in the will, should the joint owner die before the property is sold. This kind of agreement is recommended in joint buy to let properties, as details of shares in ownership are made explicit, so there can be no disagreement in profit splits.
• Joint Tenants – This is where each owner has equal shares in the property, so if one joint owner dies, the mortgage is passed onto the other joint owner. Inheritance tax may apply if the joint owners are not married or in a civil partnership.

It is highly recommended that joint buy to let investors make a Declaration of Trust agreement, which is a legal document containing the length of notice either party should give if they wish to exit the mortgage, and details of how the property should be sold on in the future (i.e. who has first refusal of shares if one person wants to sell and how profits from rent should be split).

Taxing Joint Buy to Let Properties

If you are joining up with another person to purchase a Buy to Let Property, be advised that there are some differences in the taxes charged, as well as provisions that need to made for the income received in rent.

Stamp Duty – In terms of stamp duty, you may be charged an additional 3% on top of conventional stamp duty rates for every property share worth over £40,000. For instance, if you own a 30% share in a buy to let property that costs £275,000, you may be charged 8% of the property’s value as stamp duty.

Capital Gains Tax – When it comes to the sale of a buy to let property, the first £11,100 profits may be exempt from capital gains tax. However, if you are a joint buy to let mortgage holder, this increases to £22,200.

If you are thinking of taking up a property investment using a Buy to Let Mortgage, it is a good idea to speak to an independent mortgage advisor, as they can help you find the best deal for you. Get in touch for a free, no-obligation buy to let mortgage quote.