As with all other aspects of the UK housing and property market, there is no one-size-fits-all answer to the question of whether buy-to-let mortgages are a good idea. What is universally true, however, is that the devil is in the detail. If you are hoping to obtain a buy-to-let mortgage for an investment property, then it is vitally important to do your research and consider where and what property type to buy. There are of course factors such as the desirability of owning a property locally and being able to keep some oversight regarding tenants and maintenance. Yet there are far fewer constraints than there might be when considering where to buy a home you intend to live in.
So the world is your oyster. Buy-to-let deals have in recent decades provided significant income and return on investment for many in the UK. However, a word of caution: the housing market has changed together with the overall economic situation, so that pre-2008 mortgage wisdom cannot be applied today. The rise in long-term arrears, and the high price of housing stock, together with the generally higher cost of buy-to-let mortgages (in terms of arrangement fees, if not higher interest rates), means that you should consider very carefully whether your own situation makes this a suitable investment option. Consulting a good buy-to-let property guide is always recommended.
Buy-to-let mortgages: pros and cons
The key here relates to the relative riskiness of taking out a buy-to-let mortgage, set against the potential return on even a small investment in property that then generates a regular rental income and potentially also appreciates in value over time.
Buy-to-let as a concept involves the use of capital investment with borrowed equity to provide a greater return through buy-to-let profit than would be obtained by investing the capital in other schemes. The aim is to maximise your borrowing at the lowest possible cost.
The principle behind the sustained attractiveness of buy-to-let mortgages as an investment strategy for private investors is known to mortgage professionals as “gearing”. ”Gearing” refers to the ratio of capital investment to borrowing. Being highly geared will mean investing a small amount of capital in the property in proportion to your borrowing commitment. In times of rising house prices and rental incomes, this can provide a significantly high return on investment. However, in a falling market, the potential for losses is equally great. Gearing accelerates either profits or losses.
Gearing is thus a principle that works well in a rising market. Currently, buy-to-let with low gearing (i.e. with proportionally larger deposits) is more secure and lenders are more likely than they were to insist on large deposits. As a rule, they will not let you borrow more than 75% of the property value through a buy-to-let mortgage. How much you will be able to borrow is also strongly linked to the estimated rental income of the property.
In the past, when property prices appreciated, the buy-to-let property could be remortgaged to release the additional equity, which in turn could be used to obtain another buy-to-let property. This has made it possible for people to build up property portfolios, and it is still those with multiple properties that have the best chance of obtaining buy-to-let mortgages.
Interest only is the rule
Most buy-to-let mortgages are interest only mortgage deals. This is because it is the aim of most investors to obtain rental income to pay the interest and to make a profit when the property is sold again. There is a dual benefit to doing so here: firstly, because monthly repayments are lower than they would be with a repayment mortgage, and secondly, because the interest part of the mortgage payment can be deducted from the rental income before tax is paid on it. This benefit does not apply to the repayment element of mortgage payments.
However, if there are problems with mortgage payment, and if the property depreciates in value, there is a risk of making large losses rather than profit.
Therefore, the risks of buy-to-let mortgage borrowing become greater in a falling or stagnating property market. In such situations, if you are highly geared (have high mortgage borrowing and little capital invested) and have all your investments in property, you will be vulnerable to downturns in the market that could lead to repossessions and even impact on your own home. Consider therefore when budgeting whether you can weather unforeseen changes. These include rising interest rates, falling house prices, difficulties finding tenants, and maintenance responsibilities.
Finding your ideal buy-to-let property
Six questions to ask:
1. What is the real value of the property?
Location is as crucial as it will be for residential homeowners. Consider the local infrastructure, the local economy, transport and regeneration plans. The ideal location will be a future hotspot, where property will appreciate and demand for rental property is rising. In 2013, London and the South East have defied stagnation still seen around the UK with a new and significant rise in house prices. Yet if you do not have the capital available to invest in buy-to-let in London, there are other, cheaper areas where the return on investment can be good: recent research suggests that one-bedroom flats in Wales can provide some of the best yields in the UK for buy-to-let landlords.
2. What is a realistic rental income?
Some estate agents may inflate this estimate to get a sale, so be wary and do your own research locally until you are confident you know the local lettings market.
3. What do you want the property to do for you?
Consider what the investment is meant to provide you with in return: Is it intended to provide retirement security, pay for school/university fees, or provide grown-up children with financial support? Undertake a realistic assessment of whether this is the best way to achieve this.
4. Will the property need work?
Can you rely on builders/decorators? Word of mouth is the most reliable and cost-effective way of ensuring a good deal here. Otherwise, there are specialist companies now advising buy-to-let landlords on contractors.
5. Should the property be furnished or unfurnished?
A property with carpets and curtains will generally be regarded by the tax authorities as “furnished”. Remember that furniture depreciates. Fully furnished properties are, however, well-suited for short-term rental arrangements.
6. New-build or older property?
Older properties have more character and are in greater demand, but sales price will be higher. New-builds may seem less risky in terms of maintenance costs, but this is not guaranteed.
Alternative ways to invest in property
Investing in property is seen as relatively secure, yet tying your investment to a particular property and taking on all the responsibilities related to this through a buy-to-let arrangement is not the only way to do this.
Another way to invest in property is to invest in property funds, although most concern commercial rather than residential property. Some, however, now do invest in residential homes. This can be a lower-cost way of benefitting from rising housing prices. These investments can be bought via an ISA, cutting both income and capital gains tax. However, as with any other relatively new product, the pros and cons should be carefully investigated – details on the award-winning HouSa investment programme from Castle Trust can be found here.