80% buy to let mortgage

If you want to invest in a property to rent out you will need a buy to let mortgage, unless you have enough money to buy it outright.

Row of houses

Think carefully before securing other debts against your home. Your home may be repossessed if you do not keep up repayments on your mortgage or any other debt secured on it.

Most buy to let lenders require a deposit of at least 25% of the cost of the property. So, if you are buying a house worth £100,000, you must pay £25,000 up front and the remaining £75,000 will be in the form of a buy to let mortgage.

There are some lenders who will allow you to make a 20% deposit, so in our example above you would need to find a smaller sum of £20,000. The other £80,000 would be borrowed via a buy to let mortgage. 

Another way to refer to this is an 80% loan to value (LTV) buy to let mortgage. This means that 80% of the house is mortgaged. 

Why take out an 80% buy to let mortgage?

The most common reasons for going with an 80% LTV mortgage are because you don’t have enough cash for a higher deposit. 

It could also be that you want to buy a more expensive property perhaps because you feel it will bring in a better rental yield.

If you already own property you might want to expand your portfolio and the only way you can afford to do that is by accessing higher LTV products.

Disadvantages of an 80% buy to let mortgage

When loan to values go above 75% this is referred to as higher LTV lending and therefore deemed to be riskier from the lender’s point of view. By risk, lenders mean the risk of you not paying back the money you have borrowed.

The higher the risk, the more expensive the mortgage will be, so the interest rate you pay will be more than if you had a 25% deposit. Similarly, if you had a 40% deposit, i.e. an LTV of 60%, your interest rate would be even less as the risk is regarded as lower. 

Interest-only or capital and repayment

Most buy to let mortgages are interest-only which means you only pay the interest on the loan. If you take out a £80,000 mortgage for 20 years, at the end of the 20 years you will still owe the lender £80,000. 

The reason buy to let tends to be interest-only is that it keeps the monthly repayments low. Because the property has been bought as an investment, you get a regular income and have the option of selling the house or flat further down the line. 

Hopefully the property would have gone up in value so you are able to repay the lender while making a profit – you will have to consider paying Capital Gains Tax though.

A capital and repayment mortgage is where you pay the interest and a repayment on the capital (the price of the property) each month. This means that the mortgage reduces every month until eventually you owe nothing.

You might decide to take a capital and repayment buy to let mortgage if you want to live in the house at a later date but your monthly payments will be much higher. 

What is rental yield?

Before taking the plunge, you should investigate whether it will be worth your while investing in a buy to let property. You can do this by working out the rental yield, which is the return you get on renting your property compared to what you paid for it.

To work out the rental yield use this calculation:

Annual rental income divided by the value of the property x 100

Example

Rent: £600 per month = £7,200 per year 

Property value: £100,000

£7,200 ÷ £100,000 = 0.072

0.072 x 100 = 7.2

Therefore, your rental yield is 7.2% before taking into account any costs accrued throughout the year. A good rental yield is considered to be at least 7% so our example here fits the bill nicely.

How do lenders decide if you are eligible for a buy to let mortgage?

There is a lot to consider when investing in a buy to let property and it is not just about the rent you receive each month being higher than your mortgage repayments.

When lenders are considering a buy to let mortgage application, they assess the risk of lending to you by using a stress test and income coverage ratio (ICR).

What is a stress test?

A stress test is where the lender applies a higher interest rate than you are actually paying. This gives lenders a clearer picture as to whether you can afford to pay the mortgage in the future if, for example, interest rates rise. Most lenders currently use a stress test of 5% or 5.5% but if you have bad credit it could be higher to reflect that you are a riskier borrower.

What is income coverage ratio?

The ICR is how much rent you need to charge compared to your mortgage payments and is expressed as a percentage.

The lender will instruct a valuation to be made on the property and the valuer will provide the lender with a recommended monthly rent. The rent must fit in with the lender’s ICR.

The rate of the ICR will depend on a number of factors including:

  • The lender

  • The product

  • If you are a low or high tax payer

  • If you have good or bad credit

  • How many buy to let properties you own 

  • Whether you have formed a limited company

The minimum ICR is usually 125%, and many lenders ask for higher than this, often 145%. 

Example

Let’s assume you are a first time buy-to-let landlord and your lender requires a 145% ICR and applies a stress test of 5.5%. 

You have chosen a 2-year fixed rate buy to let mortgage with an interest rate of 3.5%. But remember, the lender does not use the actual rate of 3.5% in its affordability calculations, it uses the stress test of 5.5%.

The property you are buying is £100,000. You pay a 20% deposit of £20,000 and need to borrow the other £80,000.

£80,000 x 5.5% (stress test) = £4,400 

£4,400 ÷ 12 months = £366.67 interest-only payments

£366.67 x 145% (ICR) = £531.67

You would need a minimum rental income of £531.67 to borrow £80,000 on an interest-only basis.

Using the above example of the rental yield calculation, the £600 rent would be acceptable to the lender as it is higher than £531.67.

Buy to let costs

The reason the rent must be higher than the mortgage again boils down to risk. Landlords receive rental income but they also have costs and should have a contingency budget for emergency repairs. 

You should be mindful of paying for regular maintenance, buy to let landlord insurance, annual safety checks and fees if you use a lettings agency. If the property is vacant between tenants, there will be no rental income. And of course, there is tax to pay on any profit you make.

Buy to let mortgage costs

You will have costs attached to the mortgage including the valuation fee and legal fees. The mortgage product may also come with any one or more of the following:

  • Application fee

  • Arrangement fee

  • Completion fee

  • Product fee

Lower interest rates usually come with higher fees and higher interest rates generally have lower fees so bear this in mind when choosing your mortgage. 

There is also likely to be an early repayment charge (ERC) if you redeem the mortgage before the end of the deal. For example if you have a 2-year fixed rate mortgage you will have to pay a fee if you want to get out of that deal before the 2 years are up. 

Stamp duty

Anyone buying more than one property in England and Northern Ireland must pay an extra 3% stamp duty on any additional properties. 

At the moment, until 31 March 2021, there is a stamp duty holiday on residential homes under £500,000. So, if you buy a £200,000 property as a buy to let, the stamp duty will be 3%, equating to £6,000.  

However, when the stamp duty holiday ends, homes between £125,001 and £250,000 must pay 2% stamp duty plus the 3% surcharge for an additional property, taking the total stamp duty to 5%. From 1 April 2021, a £200,000 property would therefore incur a stamp duty charge of £10,000.

Scotland and Wales have different stamp duty charges. In Scotland it is the Land and Buildings Transaction Tax and in Wales it is the Land Transaction Tax.

Do I need to have a job to access 80% LTV buy to let mortgage?

It depends on the lender as to whether they require a salaried income when you take out a buy to let mortgage. 

Some lenders require a minimum income and this varies between them. The lowest income is usually £20,000 a year but other lenders may require £25,0000 or £35,000.

Where lenders do not state a minimum salary, this is usually because they will accept the rental income from the property as proof that the mortgage can be repaid.

What is top slicing?

If you do have a job some lenders will use your salary for ‘top slicing’. This is where the borrower’s salary is taken into account but not all lenders will consider this. It is usually used if the rental income falls short of what the lender requires.

Let’s go back to the previous example where the rent is £600 on a £100,000 property. If the rent was only £500, it would not pass the lenders calculations as the lender requires a rent of at least £531.67.

To make up for this shortfall the lender can take into account the borrower’s income, along with monthly outgoings. If there is enough money left over, the lender can accept that as proof the borrower can afford the monthly repayments.

80% LTV buy to let mortgage and house prices

House prices generally rise over time (they could also fall though). For example, the September 2020 Land Registry figures showed an annual rise of 4.7% in house prices across the UK. 

But a year ago in September 2019, the average annual house price growth was 1.3%. This means that over the past 2 years house prices have risen by an average of 6%.

Lowering your LTV

If you start with an 80% LTV mortgage, in a few years’ time your property may be worth more than when you bought it. When you come to remortgage, the LTV will be less than 80% meaning you can apply for a lower LTV mortgage at a more competitive rate. 

Bear in mind that mortgage rates may be higher in a few years’ time as they are currently at or near historical lows.

Negative equity

If house prices do drop, which often happens in a recession, properties that have a high LTV mortgage could fall into negative equity - where the property is worth less than you paid for it.  

This could be a problem if you need to sell the property. If you can hold onto it until prices rise again, you may get your money back.

If you're a first time buyer or looking to move house or remortgage, we can help you find the best mortgage deal to suit your needs.