A Beginners Guide to Buy - To - Let
What is a buy - to - let?
A buy-to-let is where a property is bought specifically to be rented out to tenants rather than lived in by the purchaser.
Investors can make money by generating an income via the rent charged, making a capital gain when they come to sell, or in many cases, both.
But like all investments, there are risks attached to buy - to - let. For example, you could be hit by rising interest rates, stuck with difficult tenants or unable to sell if the housing market changes.
What is a buy - to - let mortgage?
If you cannot buy your investment property outright, you will need to apply for a mortgage, which will have to be a specific ‘buy-to-let’ mortgage. A standard or ‘residential’ loan is only relevant when you plan to live in the property.
There are differences between a residential mortgage and a buy-to-let mortgage, and they start with the way your affordability is calculated.
Instead of your salary, the lender will view the potential rental income of the property as your primary income source. Many lenders will then take your personal income into account as a secondary factor.
Typically, a lender will want your rental income to meet at least 125% of the monthly mortgage interest payments on the loan, a calculation known as ‘rental cover’. For example, if the mortgage payment amounts to £1,000 a month, you would need to demonstrate rental income of £1,250.
Rules set down by the Prudential Regulation Authority in 2017 recommend that lenders increase this rental cover to at least 145%, meaning you would need to demonstrate rental income of £1,450 on the same monthly mortgage interest payment of £1,000.
Regardless of the actual mortgage rate the lender offers, the interest used in the rental cover calculation should be at least 5.5%, according to PRA rules.
This leeway factored into rental cover calculations reassures the lender that you will still be able to meet your mortgage commitment if you were to have ‘void’ periods when the property is without tenants, or the rent has not been paid. A deposit on a buy-to-let mortgage also tends to bigger than the one required for a standard residential loan. Most buy-to-let lenders expect a deposit of at least 25% and the very cheapest deals usually require a deposit of 40% or more.
What sort of buy - to - let property should I buy?
When looking for a property think about the area and what your potential target tenant would be. For example, Aylesbury has a high demand for medical staff due to Stoke Mandeville Hospital; Oxford has a high demand for students, due to its universities. There is always a niche for certain types of property, which there is a potential to thrive from.
How do I choose where to buy?
If you are not buying in an area you are familiar with, then speak to a good local letting agent who can advise on what kind of properties are in demand and how much they rent for. You can check the average property values for an area online and see how much properties are renting for in the area.
Do I want capital growth or good rental returns?
As a buy-to-let investor, you will either be relying on capital growth (increase in the value of the property over the medium to long term) or rental yield (income generated from the property expressed as a percentage of the property value) and hopefully both!
What will my responsibilities be as a landlord?
Being a landlord does come with certain legal responsibilities. Your tenants must be assured that their right to live in your property is protected by a tenancy contract and that their deposit is safe.
The most popular tenancy contract is an Assured Shorthold Tenancy (AST). These give tenants a legal right to live in the property for a fixed duration or on a rolling term.
An AST lasts for a set period, usually 6-12 months. It will detail rent costs, who is responsible for repairs, notice of eviction, when rent can be increased, how long the tenancy lasts and the tenants right to have their deposit protected.
Deposit protection schemes are a legal requirement. There are two types of government-backed deposit schemes, insurance and custodial.
Under an insurance scheme, the landlord or agent retains the deposit and pays the interest to the insurer.
The custodial option, where the deposit is paid directly into the scheme, is free of charge to use.
It is also your responsibility to ensure the tenant have the right to rent in the UK.
What is buy - to - let insurance?
This provides cover for buildings and contents as well as landlord liability.
Buildings Insurance – Most landlords will be required by their lender to take out buildings insurance before they can secure a mortgage on a property. This will pay out in the event your property is damaged or destroyed and needs to be repaired or rebuilt.
Make sure you input the correct rebuild value on your buildings insurance form. This is different to the amount you paid for the property, so if you are uncertain consider getting a charted building surveyor to do a valuation for you. If you previously lived in the property and already have ‘residential buildings insurance’ in place, it is important that this is changed to insurance for a ‘buy-to-let’.
Contents Insurance – This covers your furniture, carpets, curtains and white goods in the property. Your tenants will be responsible for insuring their own belongings within the property.
Landlord Liability – This will cover you in the event of the injury or death of tenants and visitors on your property.
Buy-to-let tax implications
Tax on rental income – The rent you receive from your property will be taxed at your relevant tax band. You can deduct some costs against the amount of tax you pay. These costs include letting agent fees, buildings and contents insurance, council tax and utility bills (if you pay them on behalf of the tenant) and essential maintenance. Landlord letting furnished properties can no longer claim 10% ‘wear and tear’ costs against their tax bill. Instead they can only claim for the actual costs of any damage repairs. As of April 2020, relief on mortgage interest was capped for all landlords at the basic rate of 20%, regardless of whether you are a higher rate (40%) or additional rate (45%) taxpayers.
It is always best to seek the advice of an accountant.
Capital Gains Tax – Buy-to-let property is not exempt from Capital Gains Tax. This tax is paid when you come to sell the property and calculated on any increase it has undergone in value. You do have allowances, though. For the 2019/2020 tax year, the first £12,000 profit is CGT free. For couples with joint assets, this doubles to £24,000. You can also offset the purchase and selling costs against your CGT bill at this stage e.g. Stamp Duty, solicitors and estate agent fees.
Stamp Duty – You must pay Stamp Duty Land Tax if you buy a property or land over a certain price in England and Northern Ireland. The tax is different if the property or land is in Scotland and Wales. How much you pay depends on whether the land or property is residential, buy to let or commercial.
You can use HM Revenue and Customs’ (HMRC) to work out how much tax you will pay. If you have a solicitor, agent or conveyancer, they’ll usually file your return and pay the tax on your behalf on the day of completion and add the amount to their fees.