How do buy to let mortgages work?

What is buy to let?

It is the purchase of a property that you will rent out to somebody else.

You can use a specific buy to let (BTL) mortgage to purchase the property. This means you can buy property as an investment without needing to save up the full amount to buy it outright.

You then let out the property and act as the landlord for the people who rent it. You charge them rental payments to cover the mortgage and your other costs.

How to make money from buy to let

The rent you charge should pay your mortgage, but you can make a profit too:

• Rental income: The rent you charge should be more than the cost of the monthly mortgage repayments. Although there can be other costs like repairs or letting agent fees, you may still be able to keep some of the rent yourself.

• Capital growth: You can make money if you can sell your property for more than you paid for it. The property's price would have to increase more than the rate of inflation.

What types of buy to let mortgage are there?

You can get most types of mortgage for a buy to let property. You will need to decide if you want a fixed, variable, tracker, discount or capped interest rate. Here is how to decide between them.

What type of mortgage is right for you?

Interest only or repayment?

Most buy to let mortgages are interest only, which means your monthly repayments just cover the interest owed and the amount you borrowed will not go down.

You will need to pay off the balance at the end of the mortgage term, usually around 25 years. You could sell the property to do this and keep any profit you make.

A repayment mortgage will pay off the entire amount you borrowed by the end of the term. This means you could either:

• Keep the property and continue to rent it out, keeping all of the rent money yourself

• Sell it and keep the full sale amount

Repayment mortgages cost more per month so are only suitable if you can charge enough rent to cover it.

How much does buy to let cost?

Costs of buying the property

You will have to pay all of the same costs of buying a property for yourself like mortgage and solicitor fees.

Some fees are likely to be higher than on a normal mortgage:

• The deposit: Many lenders require a deposit of at least 25%, and some need even more.

• Mortgage fees: Several charges that come with the mortgage, like the arrangement fee, may be higher.

• Stamp duty*: You have to pay stamp duty on any property worth more than £40,000 if it is not your main home. The amount is higher for buy to let than residential properties.

*In Scotland you pay Stamp Duty Land Tax instead.

Costs of owning the property

Once you have bought the property, you may have to pay for the following:

• Renovating and improving it to make it legally safe to live in and attractive enough for someone to rent it.

• Paying your mortgage every month, which is likely to come with higher interest rates than a normal mortgage. This explains how much a mortgage will cost you.

• Paying letting agents for advertising the property and managing your tenants, which is usually charged as a percentage of the rental income.

• Maintaining the property and making any repairs needed. You can check what repairs you have to make on the GOV.UK website.

Tax on your buy to let investment

You will pay tax on the profit you make from your buy to let investment, including:

• Income tax on profits you make from rental income

• Capital gains tax on profits you make from selling the property

The amount you are taxed on is the profit you have made minus allowable expenses like:

• Interest on your mortgage

• Maintenance and repairs

• Insurance

• Letting agent fees

• Utility bills you pay

You can work out your rental income and how much tax you have to pay on the GOV.UK website.

Changes to taxation mean you are not able to offset mortgage interest against tax from 2020. This calculator helps you work out if you will make a loss or profit.

Who can get a buy to let mortgage?

Each lender has different requirements for buy to let mortgages but they will only accept your mortgage application if they think you can afford it.

They will base this on:

• How much rental income they expect you will get from the property

• Your financial circumstances

These will also affect how much they will be willing to lend to you.

Your rental income

Lenders will look at how much rental income you will get from your property and compare this to the monthly repayments you would make on the mortgage.

The rental income will usually need to be at least 125% of your mortgage repayment. This means it would need to cover the full mortgage payment plus another 25%.

For example, if your mortgage repayments came to £400, you would need to be able to charge at least £500 rent each month.

They will ask you to confirm the annual rental yield and check you are likely to get this much by looking at how much similar properties in the area charge.

Your financial circumstances

Lenders will decide if you can afford the mortgage by looking at how much the repayments will be and:

• Your credit record: Your current borrowing and how well you have kept up with repayments is on your credit record, which helps lenders decide if they want to offer you a mortgage.

• Your income: Many lenders only accept you if you earn more than their minimum, usually around £25,000 each year.

• Your outgoings and existing debts: They will check what you spend and what you already owe on the mortgage on your own home, loans and credit cards.

• Your deposit: A higher deposit should make it easier to get accepted.

What are the risks of buy to let?

You should avoid investing in property if you cannot afford to risk losing money. You could make a loss in the short term or overall if:

• Your property is empty: If you cannot find tenants, you will make no rental income, meaning you will need to pay the mortgage yourself.

• You need to repair the property: You may need to spend money on fixing the property if it is damaged by tenants or by issues like subsidence or extreme weather.

• You have problem tenants: If they refuse to pay rent, damage your property or steal your belongings, you will be out of pocket. Here is how to deal with difficult tenants.

• Interest rates rise: Your costs could increase if mortgage interest rates rise because this will push up the amount you need to repay each month.

• House prices fall: If you took out a buy to let mortgage and eventually sell the house for less than the mortgage amount you took out, you could make a loss. You will need to pay off the rest of its balance yourself.

Get landlord insurance

You can protect yourself against the risks of being a landlord with insurance policies to cover your buildings, contents, legal liabilities and rental payments.

Here is what landlord insurance can cover and how to choose the right policy.

How to get started with buy to let

1. Decide if you can afford to invest in property and if it is right for you

2. Carefully choose a property that is within your budget, desirable to renters and likely to make you a profit

3. Find a mortgage using our comparison table, which includes every buy to let mortgage available

4. Get advice from an independent financial adviser or mortgage broker if you need help

Here is everything you need to know about getting a mortgage