A Buy-to-let mortgage is a lending product designed to allow a potential property investor to purchase a residential property to let to tenants on an assured shorthold tenancy basis.
Buy to Let mortgages are similar to those used for owner occupied properties, only in so far as they charge the asset in favour of the lender as security for the loan. In other words, if the borrower does not pay, or breaks a mortgage condition, the lender has the right to repossess the property, sell it and attempt to recoup its losses.
There are, however, many differences between buy-to-let mortgages and standard residential mortgages, mainly because BTL is, in effect, a commercial mortgage, albeit one secured on a residential property.
We’ll take this opportunity to look at some of the differences between buy to let and residential mortgages.
Deposit and Interest Rates
Whilst post credit crunch deposits required for residential mortgages tend to be higher than pre credit crunch, they are currently as low as 5%; pretty low and at 15%, the interest rates available are very good.
However, in the BTL world, typically, the highest LTV mortgage (loan-to-value) available is 85%, at quite a high rate of interest and applications at this LTV, often fail due to the lender’s interest cover ratio which we cover in more detail further down the page.
As with any mortgage loan, lower LTVs, generally mean lower introductory rates of interest, because the lender is carrying less risk. At 65% LTV, the buy to let mortgage interest rates available at the moment are not far off the 80% residential mortgage interest rates.
Availability of Interest only Mortgages
The good news is that, unlike in the world of residential mortgages, where regulatory scrutiny has caused lenders to all but withdraw the availability of interest only mortgages, they are alive and kicking in the buy to let mortgage world.
This is good news and, of course, right and proper, for a couple of very good reasons.
Interest only reduces the cash flow burden on the investor and should make it less likely that the borrower defaults, which is also good for the lender.
Tax: interest only mortgages reduce the investor’s tax burden, which is great. If a repayment loan is selected, each payment consists of part interest and a part capital repayment. Each year that goes by, more of the monthly cost becomes capital, which means that there is less interest payable that can be offset as a cost against rental income. The tax burden is actually increasing!
Of course, for older investors, of which there are bound to be more with the relaxation of the harsh annuity regulations, the availability of interest only mortgages is essential.
Types of interest rates
Unlike full commercial mortgages, which are often on a variable rate of some sort, there is some degree of choice available when it comes to a BTL Mortgage. Here is an explanation of the various options available to investors.
Well, this one does exactly what it says on the tin, the rate is fixed for a specified period and there are usually ERCs (early repayment charges), if all or part of the loan is redeemed during the period.
The key question here is what does it track? The majority of products track at a margin over Bank of England Base Rate, however some track LIBOR or other indices. Your mortgage illustration should tell you which index the rate tracks.
These are floating rates, and are usually a margin of discount below the lender’s SVR, that’s Standard Variable Rate, for a period of time. After the initial period, the interest rate reverts to the lender’s full SVR, which is usually higher. It must be remembered that a lender is free to raise its SVR at any time.
With a capped rate product option, the interest rate is variable, however the product will have a maximum ceiling rate of interest. So if the cap is at 5%, that is the most that you will pay, for a period of time; regardless of the prevailing B.O.E. base rate. These are rare in today’s market.
Standard Variable rate
In the case of SVR mortgages (Standard Variable Rate), the lender sets its own rate and is free to move the interest rate up or down; however, changes tend to follow moves in the Bank of England Base Rate. These mortgages do not usually have any Early Repayment Charges associated with them, which can be useful.
This is infinitely variable and is dependent on the type of business that a lender wants to attract at the time. There are three areas that lenders focus on:
- The borrower: income – some have a minimum income requirement, some do not. They will also look at your creditworthiness
- The property: some may take a flat above a shop, or a flat with a lease of only 50 years unexpired, others will not
- The Loan Purpose: some may lend on a property that will be used as a licensed HMO (house of multiple occupancy). If re-mortgaging, most lenders are happy with a capital raise for further property investment
- Interest Cover Ratio; some lenders insist that the projected rent covers the mortgage interest by 125% of the actual pay rate at the time or their reversionary SVR, others will set a notional interest rate, e.g. 6%. This offers them some protection against you defaulting due to voids and or rising interest rates
The same fees that are payable in association with a residential mortgage application are payable in connection with a BTL mortgage…..however, arrangement fees tend to be higher. Arrangement fees can be as high as 3.5% of the value of the loan. Other fees include valuation fees, Surveyors fees, if a more comprehensive report on the property is required and legal fees. Arrangement fees can often be added, even if to do so, takes the loan above the LTV band for the product chosen. For re-mortgages you might get ‘fees free’ packages which include a free basic valuation and free standard legal fees but will not cover extras like a transfer of equity for example.
Don’t underestimate the value of the services that a mortgage broker can bring to the table. A good one will have solid mortgage, property and legal knowledge. This advice can help not only to secure you a great deal that you, the borrower, can’t acquire yourself by direct means, but also to avoid abortive costs, or worse, purchasing the wrong property! Now, with new mortgage regulations, lenders have tightened up even more than before, so to make sure you are choosing the most appropriate lender and product give your mortgage broker a call today.