Bricks and mortar have been a pillar of British retirement plans ever since the birth of the buy-to-let mortgage more than 26 years ago.
It’s a tried and true strategy which – if done properly – gives investors two sets of returns; rental income and capital growth of their underlying asset. More than half of landlords have invested in property as part of their retirement plans, according to the English Private Landlord Survey.
But property investment is not without its pitfalls, and recent tax and regulatory changes have triggered an exodus of landlords from the sector.
Becoming a landlord is not for the faint hearted; research is vital to ensure your investment remains a good one. In this guide we will cover:
Most landlords who don’t earn their rental properties outright will need to get a buy-to-let mortgage to cover their borrowing.
The way in which lenders assess affordability for a buy-to-let mortgage differs from a typical homeowner loan. A borrower with a homeowner mortgage will be assessed for affordability on their income, but a buy-to-let borrower will be assessed using an interest-coverage ratio (ICR).
This metric requires basic-rate taxpayers to have a rental income on the property at least equal to 125pc of the monthly mortgage interest – this rises to 145pc for higher-rate taxpayers.
A lender will use rental valuations on similar properties in the same area when assessing affordability on a new buy-to-let purchase.
Nicholas Mendes, of broker John Charcol, said most lenders will also require buy-to-let borrowers to be earning a minimum of between £15,000 and £20,000 outside any rental income.
He said: “Banks do not want to lend to a borrower who will become dependent on rental income straight away. They want to make sure you could still afford payments if you were relying solely on your own income, if there were ever any gaps in the rent.”
Most landlords choose to pay their mortgage on an interest-only basis to keep monthly costs down, so if you sell the property you will still need to repay the initial loan amount.
Most lenders require a deposit of 25pc of the property’s purchase price, although some will accept 20pc.
As with a normal mortgage, borrowers who put more equity into a property are less risky customers for lenders and will qualify for better interest rates.
In addition to a deposit, you’ll also have to factor in the higher cost of stamp duty. There’s a 5pc surcharge for second homes and buy-to-let properties, which means someone buying a £300,000 investment property in England or Northern Ireland would have to pay £17,500 in tax, compared to £2,500 if you were a homemover.
Our stamp duty calculator shows how much you should be prepared to pay. Properties in Scotland and Wales will be subject to similar taxes, but these have different rates and thresholds.
The exception to this rule would be if a landlord were also a first-time buyer. They would not incur the second home stamp duty surcharge, but nor would they qualify for any first-time buyer tax relief, and instead pay standard rates.
Be aware that buying an investment property as a first-time buyer might also cause issues with mortgage lenders, who prefer buy-to-let borrowers to already have their own property.
Mr Mendes said: “If you are a first-time buyer applying for a buy-to-let mortgage, some lenders will either decline it or require an additional party on the mortgage who isn’t a first-time buyer.”
Prudent investors will also need a cash reserve for maintenance costs and unexpected gaps in rental income, says Robert Jones of Property Investments UK.
He said: “We recommend investors have a separate pot for surprise costs. In the best case scenario this would be enough for six months of mortgage payments on top of maintenance and repair costs.
“A middle ground would be enough to cover unexpected repair and maintenance costs, without enough to cover mortgage payments in the event of a rental void.”
As a rough guide, landlords should set aside 1pc of the property’s value to cover annual repairs and maintenance. So in the case of an average £213,000 rental property, ring-fence £2,130 for upkeep each year.
The initial cash injection in an investment property will be higher if it requires renovation or has a poor Energy Performance Certificate (EPC) rating. While EPC requirements were shelved by the previous government, Labour is planning to require all rental properties to achieve at least a “C” grade by 2030.
