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How Buy-To-Let works

Richard Campo, founder and managing director of our recommended mortgage and protection advisors, Rose Capital partners, explains how Buy to Let investments work.

The ‘Buy-To-Let’ (or BTL) market is extremely wide, varied and complex. So in the interests of making this blog readable, I have focused as tightly as a I can on the main points and principles so you can get a good overview.

This type of lending can simply be defined as a property you are looking at buying, or already own, that will be rented out to a third party.

Remember, as a brokerage we come at this from a perspective of doing the best by our clients. We aren’t interested in pushing the lenders agenda but rather how can you maximise what you are doing. For some, that will mean maximum leverage (borrowing as much as they can), for others, minimising costs or even consolidating or de-leveraging.

How much can I borrow?

Generally, the most common question asked when it comes to any lending and this is no different! Sadly, there is no straight answer. I will outline a few key metrics and some hopefully workable maths you can take away with you. Be warned, this isn’t simple and we recommend speaking to a qualified adviser if you are to go down this path. Factors that will have an impact will be things like your personal income, your credit profile, deposit available and if you are buying the property in your own name or via a company. It will be best to explore how these assessments are made next.

How is the assessment made?

The primary driver for what you can borrow is the rental income. Unlike residential loans, BTL is not regulated by the FCA (Financial Conduct Authority) but instead governed by the PRA (Prudential Regulation Authority, a sub-division of the Bank of England) so different rules apply. The PRA’s standard calculation for this is:

  • You can borrow 145% of the annual rental income, based on a ‘stress’ rate of 5.5%
  • E.g. £1000 of rental income = £150,470 of borrowing
    • The maths works out as £150,470 x 5.5% (the stress rate) = £689.65 per month
    • £689.65 x 145% (the Interest Cover Rate) = £1,000
      • Or conversely, for each £100 of rental income per month = £15,047 of borrowing. So rental income of £2,800 = £421,316 of borrowing (28 x £15,047)
    • Lenders will typically do this purely against the interest on the loan. This is because most BTL’s are arranged on an interest only basis.

Some lenders will go much lower than the above and either apply a lower ICR rate (the lowest being the actual product rate you are offered), lower stress rate (the lowest being 100%) or even offer a larger loan if you take a 5 year fixed rate product. 5 year rates fall outside the enforced PRA calculation above.

The major catalysts of lower assessments will be things like:

  • Buying the property through a company. Lenders are often more generous with this as corporation tax is lower for higher rate tax payers than income tax.
  • Having a high personal income which can bolster the rental income.
  • Being an experienced landlord with a portfolio.

This is by no means an exhaustive list, but the most common ones we see. In these instances, lenders will go much lower than the above.

  • To give an example, one lender currently offers a 125% coverage of their product rate of 2.29% meaning you can then borrow £419,214 off the same £1,000 per month rental income
    • To get to this figure, you x 2.29% (the ICR) by 125% (the Stress Rate) = 2.86%, on a loan of £419,214 which comes out at £1,000 per month.
    • Using the same example as above, for each £100 of rental income per month, that equals £41,921 of borrowing. So £2,800 of rental income would equal a loan of £1,173,788 (£41,921 x 28).

As you will have gathered by now, the Stress Tests and Interest Cover Rates applied mean there is very little link between the product you are offered and how much you can borrow. The lowest rate on a BTL today is 1.37%, but that does not mean you can borrow more with that lender. In fact, the opposite is true. As illustrated above, a bank will actually offer you a rate of 2.29% but lend you £419,214, while another lender can offer you a rate of 1.37% but you may only be able to borrow £150,470. That is a difference of 279% on the amount you can borrow with 2 different lenders, on the same rental income, and the lender that offers a larger loan charges more… welcome to BTL.

Lenders offer a range of assessments. I have simply highlighted the most stringent and the most relaxed to give you an idea of the difference that then creates. As many BTL lenders do not deal with the public directly, speaking to a whole of market broker will be the only way you can be sure you are getting the right outcome for you.

How much deposit do I need?

As you will have seen by the above, the exact amount of deposit needed will be heavily dependent upon your circumstances, which is exactly why you need to speak to a qualified professional. In crude terms, you simply do the rental calculation for the lender and the product you wish to use, see what loan is then on offer, then you will have to pay the difference in cash between that and the property value you wish to buy or refinance.

As a guide, the minimum deposit needed is 15%, but as the property value gets larger, the deposit may also get larger. So for properties up to £500,000, assuming the rental income assessment works, you can borrow 85% of that figure (so £425,000, meaning a deposit of £75,000). Up to £1m, you would need a minimum of 20% and over £2m you would need 25% or more. As with all forms of lending the larger the deposit you put down, the more options you have and the cheaper the products will become. Generally when you put down a 50% deposit or more you will have the cheapest options available to you.

What are the tax implications?

I would like to heavily emphasise at this stage we are not tax advisers and do not offer tax advice. Click here for a very useful government site on this subject.

All I would say is that you need to think about the following:

  • Are you are buying the property in your own name or via a company?
  • Looking to own the property for capital appreciation or income?
  • Is it part of your pension planning?

These are key considerations when structuring the loan at the outset but also what tax implications that it will have. If you would like advice in this area speak to an accountant, property specialist or other qualified professional. We know a few great firms and would be happy to introduce you should you need it.

Are the rules different if you have a BTL Portfolio?

In a word, yes. Since the 30th September 2017, the PRA published new guidelines defining what a portfolio landlord was (along with the aforementioned Stress Tests). Which is simply anyone owning 4 or more mortgaged properties – so if you owned 5 investment properties but only had mortgages on 3 of them, you are not a portfolio landlord from a regulatory point of view. This definition is relevant as the PRA has suggested that lenders need to look at things like: property portfolio spreadsheet, cashflow forecast spreadsheet, income and expenditure spreadsheet, business plan, three months’ bank statements, SA302s and tax overviews from HMRC and tenancy agreements for all properties before agreeing to lend.

As ever, I would stress that not all lenders do all these things but do be prepared to get more documentation together than you have ever had to previously if you tip over into this category.

There are benefits to being a portfolio landlord. Some lenders (typically Commercial lenders or specialist BTL providers) will not just look at each property as per the assessments above. They often look at the total value, the total rental income and total LTV (Loan to value). This can be beneficial as if a lender has a single charge over all properties, you can often add new ones into the portfolio utilising the equity built up in the other properties without having to put your own money in, or go through a re-mortgage process to release capital. Again, these arrangements can be more complex so as such, most lenders will go to a maximum of 75% of the portfolio value, with the majority of the market preferring to stay around the 50-60% mark.

What product options are available?

All the usual product options are available. So you can have the loan on a Repayment basis, Interest Only or a mixture of the two, fixed rates from 2 to 10 years, or variable rates. If you want a detailed overview of this, you are welcome to look at the relevant section of our website here.

If I don’t own any properties, but want to buy a BTL is that an issue?

It can be. If you don’t own any property at all lenders are concerned you can ‘game’ the system by saying a property will be rented, to achieve a higher loan than can be obtained on your income, but then move into it. Therefore, of the lenders that do offer BTL mortgages to First Time Buyers or those who don’t currently own a property, it is likely the loan will be capped at what they deem you can afford on your income regardless of your deposit or rental income. There are always going to be options available to you, but do be prepared for a lender to ask questions as to why you are buying an investment before your own home. There are logical reasons for this, such as you live in London, but want to buy an investment in Liverpool. Maybe you have a job where accommodation is provided, so you are just looking to buy an investment. Or maybe your mum’s Sunday roast is just too good to move away from! Lenders do live in the real world, so will be understanding, but equally, they are going to look for a good reason.

Summary

If you have read this far (and congratulations if you have) you will have gauged that it is very difficult to ascertain how much you can borrow, what the costs will be, what the tax implications are and even what lenders are available. I can’t stress enough how important it is to get independent advice on both the finance and tax side of things. Shop around in both instances. Not all brokers have access to the same lenders or products, so ask questions about how many lenders are going to be on your panel and how many products can you advise from. You may be shocked to learn that one broker may have access to as little as 14 lenders, but are deemed ‘whole of market’ by the FCA, while others will have up to 340. This can be the difference between you being able to borrow the amount you need, or getting a cheaper or more suitable product.

 

As ever, if you want to discuss anything raised in this blog, please do not hesitate to contact us and we will be more than happy to help guide you through this quite complex market.

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