Types of BTL mortgage and BTL mortgage lending criteria
Essentially with buy-to-let mortgages as for ordinary residential mortgages, there are two main types:
This type of BTL mortgage requires the landlord to pay off the capital sum as well as the interest on the BTL loan so that at the end of the loan period the buy-to-let mortgage has been fully repaid. This is the safe option for the landlord as it guarantees that what ever happens to house prices, the buy-to-let mortgage will have been paid off at the end of the loan period.
Are there any disadvantages for landlords?
There are two basic drawbacks of having a repayment buy-to-let mortgage. Firstly, from a tax point of view it is only the interest part of the loan that can be offset by the landlord against the rental income from their residential lettings business. Secondly, monthly repayments will be higher for a landlord. This means that it is much easier for a landlord to sustain a negative cash flow with a repayment mortgage. Higher repayments means that the size of the buy-to-let mortgage that a mortgage lender is prepared to advance to a landlord will probably be smaller than that for an interest only buy-to-let mortgage currently available.
Interest only buy-to-let mortgages
This type of BTL loan requires the landlord to repay only the interest on the buy-to-let loan, in much the same way as you would with the minimum payment on a credit card. The good thing is that a landlord’s entire payment is offset able against any rental income, thereby maximising the reduction of a landlord\'s rental profits and any potential income tax liability. The ‘downside’ is that it does mean that a landlord has no means of repaying the loan at the end of the mortgage period. Sounds scary – not necessarily.
There are several options for landlords concerned about the repayment of their buy-to-let mortgage:
One option is to do nothing – continue to pay the interest and hope that the real value of the loan reduces as a result of inflation. A landlord can also hope that rising house prices cause a rise in value in their residential investments resulting in every increasing amounts of equity
The other option is for a landlord to set up a ‘repayment vehicle’. This is in essence a savings scheme structured in such a way that it aims togrow to an amount that can repay the BTL loan by the end of the mortgage period. An example of these \'\'repayment vehicles\' were the endowment policies which became almost a standard part of any mortgage until the early nineties. For more details of \'repayment vehicles\' a landlord should speak to a Independent Financial Advisor (IFA).
Mortgage companies lending criteria
Mortgage providers have broadly two approaches of measuring affordability when it comes to lending to landlords. The first maintains that any loans on a residential investment property should be assessed on the basis that the buy-to-let loan is self financing. The other approach which predominated prior to the arrival of the ‘buy-to-let’ initiative in the late 90’s, measures a landlord’s overall income against their outstanding financial commitments. The details of each approach are laid out below:
1. The majority of buy-to-let mortgage lenders now lend on the basis that the residential investment property should be self supporting. This means that the rent generated should pay for the buy-to-let mortgage along with other related letting expenses. Buy-to-let mortgage lenders therefore insist that the rent covers a minimum of 125-130% of the expected mortgage payments. In some cases certain mortgage lenders will accept a lower rental cover.
One thing for a landlord to watch out for is the interest rate used by the mortgage lender to calculate the projected mortgage cover. Some buy-to-let mortgage lenders use an interest rate that reflects a long-term average rate; others use their own variable rate. Some companies are prepared to use a mortgage calculation based on the interest only costs if that is the type of mortgage that a landlord is applying for. Other buy-to-let mortgage lenders calculate the monthly repayments based on cost for a repayment mortgage. Because this is higher it may reduce the size of the BTL mortgage that a landlord can obtain.
2. The other approach used by buy-to-let mortgage companies uses personal income as the basis of a lender judging affordability. The buy-to-let mortgage company takes a landlords salary or income after outgoings to assess their ability to repay the debt. This is a more cautious lending policy and is most suitable for high income individuals or older buyers who may be close to or have paid off their existing residential mortgage. This type of lending assessment also limits the number of properties that can be bought and therefore this type of BTL mortgage lender is not always suitable for those landlords who want to build a portfolio of residential investment properties.