What Is a Buy-to-Let Mortgage? A Complete Guide

What Is a Buy-to-Let Mortgage?

A buy-to-let (BTL) mortgage is a type of financing that allows you to purchase property in the United Kingdom (UK) specifically for the purpose of renting it out. Here is how these mortgages work, along with their risks and benefits.

How Buy-to-Let Mortgages Work

In many ways, buy-to-let mortgages are similar to other kinds of mortgages you might take out for a residential property. You will need to apply with a lender, and satisfy that lender’s criteria for eligibility, to secure the funding. Once the closing documents are signed, you will need to make monthly payments until the loan is paid off. 

However, since purchasing a property to rent out can appear riskier to lenders, you may have to go through more hurdles. Most buy-to-let mortgages also come with higher fees and interest rates compared with residential mortgages. 

Other features of a buy-to-let mortgage that differ from a residential mortgage include:

• Higher minimum deposit requirements. Most lenders will require a 25% minimum deposit of the home’s value. However, minimums can be anywhere from 20% to 40%. 
• Interest-only loans. Most buy-to-let mortgages are interest-only, meaning you’ll pay interest charges each month but no principal. Once your mortgage term is up, you then have to repay the principal amount in full. However, some lenders will structure payments to include both interest and principal. 

It’s important to note that most buy-to-let mortgages aren’t regulated by the Financial Conduct Authority (FCA) in the UK. This means that lenders may not need to follow certain regulations that they would on other products. 

However, there are some exceptions where the FCA does have oversight. For example, if you want to purchase a property so you can rent it to your close family members, you can qualify for a consumer buy-to-let mortgage. In this case, lenders have to comply with the same regulations as with residential mortgages.  

Benefits of Buy-to-Let Mortgages

Buy-to-let mortgages can offer a host of benefits for a landlord, including:

• Generating rental income. Being able to finance an investment property means that you can start earning rental income sooner rather than waiting until you can afford to buy a property outright. The rent your tenants pay can go toward the mortgage and other costs. 
• Building a property investment portfolio. Leveraging with this type of loan, as opposed to simply buying properties outright, means your available cash will go further, which can allow you to purchase additional property. 
• Potential capital appreciation. While you’re earning income from your tenants, your property can also increase in value through appreciation. You can then use that equity for other purposes, such as buying another rental property if you want to.

Risks and Challenges of Buy-to-Let Mortgages

Although buy-to-let mortgages can offer a lot of opportunities for you as a landlord, there are potential risks and challenges as well, such as:

• Rental void periods and loss of income. There may be times when you won’t have a tenant in the property, such as when tenants move out and you’re waiting on your next one. You may even face forces out of your control, such as when tenants are late on their rent or not paying it altogether. In any of these scenarios, you risk not bringing any money in, while you’re still responsible for paying the mortgage and other related costs. 
• Property maintenance and management responsibilities. As a landlord, you are responsible for taking care of the property and dealing with tenant requests. For example, if a tenant calls to let you know the radiator is broken, you will need to respond in a timely manner and get it fixed. That can mean allocating money for extra expenses to maintain the home and to hire any help you may need. 
• Changes in rental regulations and the rental market. You’ll also be subject to the various governmental regulations that apply to rental properties, which can change periodically. Keeping up with the latest regulations, and complying with them, can take time and money. In addition, you’ll need to pay attention to the local rental market so you can set prices accordingly.
• Taxes. The income you earn as a landlord is taxable. Depending on where you live in the UK, you could pay up to 48% after taking allowable expenses into consideration.
• National insurance. You may have to pay Class 2 National Insurance if you earn more than £12,570 in rental income profits per year. If you earn less than £6,725, you can choose to pay voluntary Class 2 National Insurance in order to help you receive your full State Pension.

Considerations Before Applying for a Buy-to-Let Mortgage

Before choosing a rental property and applying for a buy-to-let mortgage, you’ll want to take a few key considerations into account:

Potential Income

Having a realistic estimate of how much you could earn with your rental property will help you decide whether it’s worth making the investment. If the potential rental income is higher than your buy-to-let mortgage payments, you may be able to earn a profit. You’ll also want to take into consideration the money you may need to set aside in case there are months without tenants as well as for other expenses like taxes and maintenance costs. 

Property Location

Even if the property is in good condition and you feel you can earn decent rental income, having a rental home in a less-than-desirable location could sink our profits. Consider factors such as whether there is a saturation of rental properties, what amenities are nearby, and job prospects in the area that could entice someone to move there. 

Property Maintenance

Maintaining your rental property, dealing with tenants, and other related tasks can be hard and time-consuming work. If you can’t or don’t want to handle it all yourself, you can hire a property manager, but that will, of course, add to your out-of-pocket costs.

Taxes

Under current laws, you can no longer deduct mortgage interest on your taxes. Instead, you’ll receive a tax credit based on 20% of your mortgage interest paid per year.

If and when you sell your rental property you will need to pay capital gains tax (CPT) if your profit exceeds £6,000 as an individual or £12,000 as a couple. The tax has to be paid within 30 days after selling the home.

How to Qualify for a Buy-to-Let Mortgage

Borrower requirements. Though lenders can have their own specific criteria for obtaining a buy-to-let mortgage, these requirements are relatively common for would-be borrowers:

• Earn at least £25,000 in income per year, not including earnings from rental income
• Put down a deposit of anywhere from 20% to 40% of the home purchase amount
• Be at least 18 or 21, depending on location
• Be under the maximum age limit (usually 75)
• Have a good credit history 
• Have a loan-to-value ratio (LTV) of 75% or less
• Prove you have your existing debts under control

In some cases, lenders may also require that you already own a home, either with a mortgage or outright.

Required documentation. When you’re applying for a buy-to-let mortgage, most lenders ask for certain documentation to see whether you meet their lending criteria. Those may include:

• Proof of identity
• Current address 
• Information on the solicitor who will finalize the home sale 
• Name of the real estate agent who is helping you with the purchase 
• Proof of income, such as three months of pay slips, last P60, self-assessment tax return, or bank statements
• Proof that you have funds for the home purchase deposit 
• Mortgage statements for any properties you already own

How Much Can You Borrow With a Buy-to-Let Mortgage?

The amount that lenders may be willing to let you borrow will be based, in part, on your monthly rental income or the amount you’re most likely to earn. More specifically, your rental income needs to be able to cover at least 25% more than your mortgage payments.

Other factors that influence how much you can borrow include your loan-to-value ratio and how much lenders believe you can reasonably afford. 

How to Find the Best Buy-to-Let Mortgage Rates and Deals

Getting the best rates and other terms for a buy-to-let mortgage can help you save thousands of pounds or more.

Here are some best practices for finding the best fit:

• Shop around with different lenders and compare loan options
• Use comparison shopping websites
• Look at fees and repayment terms in addition to interest rates offered by lenders
• Consider working with a financial advisor or mortgage broker to see what options are available to you

The Bottom Line

Buy-to-let mortgages are a viable option for would-be landlords who can’t, or don’t want to, buy rental properties outright. They can be more expensive than regular residential mortgages, and borrowers should keep in mind that the costs of being a landlord can go well beyond the mortgage payments, both in terms of money and time.