Mortgages

Buy to let mortgages

With the significant rises seen in the value of property over the last few years, more people have started to view investment in property as a realistic option.

While it is true that significant gains have been made in capital values in the last few years and rental values have remained buoyant, investment in property for both income and capital return must still be viewed as a more volatile type of investment than some other traditional methods.

How does a buy to let mortgage work ?  

What security will be required ?

In the vast majority of cases a loan to assist in the purchase of an investment property will be secured be way of a mortgage over a property. The property used as security may well be the investment property itself but in some cases the borrower may choose to use their own residential property as security for the loan.

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What rate of interest will I be charged ?

Rates of interest available for buy to let mortgages vary greatly. Traditionally this sort of mortgage was considered to be more of a "commercial" proposition and as such the rates available reflected this, being higher than normal residential mortgages and only being available from a number of specialist lenders. In recent years more and more main stream lenders have experienced a demand for this type of loan and as such have developed products which cater for this market. 

While many buy to let mortgages are still structured around a variable base rate it is possible to find lenders who are prepared to offer incentives such as fixed and capped rates for this type of lending. As the market becomes more competitive and lenders recognise the potential returns available in this sector it is likely that competition will increase and rates, as a consequence, are likely to become increasing competitive. This is all good news for the investor trying to maximise the return from their investment.

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What are the tax implications ?

While individual circumstances may vary it should be appreciated that income received, in the form of rental income, is treated as earned income by the inland revenue and is taxed accordingly. It is therefore important to consider, and take advice on, your own tax position, before entering into this type of transaction.

There are however some benefits available to the investor to try and minimise their tax position in respect of rental income. In most cases the inland revenue will allow a borrower to offset interest paid on a loan used to purchase an investment property against the rent received. In some circumstances certain other expenditure may also be able to be offset so reducing the ongoing liability still further.

In the following simple example we assume an interest rate of 8% on an interest only loan used to purchase an investment property.

 

Income tax payable (assuming a rate of 23%) = £1700 x 23% = £391

While the total bill of £391 may not seem excessive, the overall return, in the example above, to the borrower is £1700 - £391 = £1,309. 

Bear in mind that £20,000 was used in the example above as a deposit on the property and this money could have been invested in, for instance, a savings account during the same twelve month period. If we assume a net rate of return of say 5% on this money then the borrower has in effect given up £20,000 x 5% = £1000 of interest during this time to achieve a return of £1,309. Although the rate of return offered by the rental property in the example above is 6.54% as opposed to 5% received from the savings account, it can be seen that, taking all the factors into account the return available is not always as attractive as it may at first seem. 

The factor that has not been accounted for in the above equation is the change in the capital value of the rental property itself. If the property has appreciated in value during the period then the effective return of the overall investment made is enhanced (although in the event of a sale there may be further tax implications through capital gains tax) but if the asset has depreciated in value during this period then the overall return may well have turned into an effective overall loss. 

It is important to note that any rise in the value of a property not used as your own owner-occupied residence will be treated as a capital gain by the inland revenue. Careful tax planning is required for borrowers who believe that they may face a capital gains liability. 

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What other factors should I consider ?

On purchase :

1. A significant deposit is often required by a lender where the mortgage is to be secured on the rental property itself. This amount can be up to 20% of the value of the property. Again this figure varies between lenders.
2. Lenders will often consider granting an additional mortgage against your own residential property to raise capital for the purchase. While the rates available may often be better with these types of loans an applicant should recognise that their own home is at risk if payments to the extra mortgage advance are not met.
3. When assessing affordability for a buy to let mortgage some lenders may not allow possible rental income to be used in their calculation of affordability. In these cases the applicants may have to show that they have sufficient surplus income from their current employment to afford the loan payments without being reliant on rental being received. In many cases this will be difficult to justify and as such may limit the number of mortgage choices available.
4. Legal costs and stamp duty are payable in the same way as a normal house purchase and must be met by the purchaser. In the case of residential property to be let out there will normally be the extra legal costs involved in setting up an assured shorthold tenancy agreement.

Running the investment :

1. If an agent is used to manage the property then a commission will normally be charged. Agents commission will vary but any costs incurred will reduce the overall return made from the investment.
2. If rent is not paid by the tenant then there may well be extra costs incurred to evict the tenant from the property. The fact that rent payments may be delayed or in some cases not paid at all will impact on the overall return. Borrowers should note that a lender will expect mortgage payments to be made on time whether rent is paid or not. The responsibility to make payments to the loan rests with the borrower and not with the tenant.
3. If a property is managed by the owner then the time invested to run the investment may be greater than that required for other more traditional forms of investing.
4. Having an investment property will have tax implications. These must be carefully detailed on your tax return and in many cases will be sufficiently complex to warrant the services of an accountant. This will of course add still further to the overall costs.

Selling the investment :

1. Fluctuations in house prices will mean that it may be difficult to assess the value of the asset accurately at any specific time. The amount received at sale may be significantly different from the amount paid to purchase and normal estate agent and legal fees will also need to be met.
2. If the property has risen significantly in value then there may well be a capital gains liability formed that will be subject to tax. 
3. Because a tenant will have security of tenure for the period of the tenancy then it may not be possible to bring the house to market in a short period of time. Usually an owner will have to wait for the current tenancy to expire before they are able to sell the property.

Although not a full list of all the factors that should be taken into consideration, it is clear from the detail above that buying and running an investment property may be more complex than you may have initially thought. 

Although the amount of work involved may seem onerous rental property has, in the last few years, provided an excellent return on capital invested and although there is no guarantee that this will always be the case the large number of high street lenders now designing mortgage products to cater specifically for rental property purchase is an indication that the market still continues to attract new customers and is likely to remain a significant feature for the foreseeable future.

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