How Does Buy To Let Work?
You may be strongly considering investing in a buy-to let property, but are unsure as to how the process works. Knowing how buy to let works in practice, as the investor or landlord could help you maximise your earnings and may also help you ensure you don’t get caught out anywhere along the way. Important to remember is that buying a property for rental, is very different from purchasing your own property to live in.
It may be the case that you are looking to diversify your property portfolio and move from commercial or retail property investments to residential, with buy to let an obvious choice. Whatever the reason for investing in the buy to let market in the UK, you will need to allow for funds to cover specific costs and ensure that your activities are legal, ethical and responsible.
What is Buy to Let?
Buy to let refers to property purchases which are either renovated in preparation for being rented out, or those properties which are immediately rented out upon purchase to tenants. Buy to let properties by their very nature are intended to provide a source of income to the property owner and landlord.
With property investments being one of the best-established investment routes, it is an increasingly popular practice across the UK. There are around two million landlords across the UK, renting out around 5 million properties, according to HM Revenue & Customs data.
It is therefore unsurprising that many investors look to invest in buy to let properties. Landlords can make considerable profits over a number of years, particularly if the property is bought at a lower price, with its value increasing over time. This in turn will mean that if the property owner decides to sell the property in question at a later date they can make a decent profit on the sale as well as through the previous rental income.
How Does a Buy to Let Mortgage Work?
A buy to let mortgage is a specific mortgage, tailored for the needs of buy to let investments. As they are not mortgages for one’s place of residence and abode, they are more expensive than regular mortgages. One of the main reasons for the increased cost is that these mortgage products come with a degree of increased risk, as many people who take them out are doing so with other personal debts such as a home mortgage. Therefore, by taking out a second mortgage for investment purposes, the risk increases for the lender that the borrower may not be able to repay.
Buy to let mortgages also require a higher deposit, usually around 40%, as opposed to the 10-20% first time buyer mortgages require. This is due to both the risk associated with these mortgages as well as lenders not being as generous as they may be when buying a home.
Another important consideration with buy to let mortgages, is that lenders tend to scrutinise the potential rental income of the property to be purchased. Only if the lender (usually a bank or building society) is satisfied that the rental income is sufficient, will they be willing to lend the mortgage you need. The criteria for a buy to let mortgage is usually stricter than that of a typical mortgage, with applicants needing to be around 25 years or older and with a minimum income of around £25,000 or more.
What Do Buy to Let Costs Cover?
Whilst there is significant money to potentially be made by investing in a buy to let property, there are costs that as the landlord, or property owner, you should keep in mind to ensure that it remains and efficient and profitable venture. This means that when you are deciding how much to charge for rent, it is wise to factor in the following costs:
● Mortgage costs (if you have taken out one)
● Whether to consider a second mortgage
● Letting agent fees
● Maintenance costs and repairs
● Buildings insurance
● Property renovations (often to improve the value of your property and increase rental yield)
Stamp Duty Charges
There were changes to stamp duty announced in 2016, introduced by the Chancellor Phillip Hammond in his autumn budget. It was revealed that there will be an increase in stamp duty costs for second homes and buy-to-let properties, equating to landlords having to pay an additional 3% on all stamp duty bands for buy to let houses.
This means in practice that say for example, you buy a property at a value of £300,000, the stamp duty that you would now have to pay as a result of these changes will be around £14,000. This is how it works:
- 3% of the first £125,000 of a buy-to-let property: £3,750
- 5% of the second £125,000: £6250
- 8% of the last £50,000: £4,000
For more details on the exact amount that you will end up paying, it is worth checking the GOV.UK website before deciding to purchase a property so you can calculate the amount you will be expected to pay for stamp duty.
It is important to note that if you are homeowner looking to buy an additional property in Scotland in order to rent out to tenants, similar rules will apply. This is because the Scottish parliament has also made changes to its equivalent to stamp duty Land Transaction Transfer Tax, introducing a hike in costs for buy-to-let landlords.
When Does Stamp Duty Not Apply?
There are some exemptions when it comes to stamp duty, such as if someone sells a house, then buys another on the same day. In such cases, typical rules pertaining to Stamp Duty will not apply.
Tax Relief on Buy to Let Properties
It is possible for landlords to offset interest for a mortgage against their income tax bills, but this is likely to change over the next few years in the UK; introducing a cap on how much buy-to-let homeowners can offset their tax bills by. This is most likely to affect landlords who are higher earners. For example, it has previously been the case that homeowners can offset their tax bills by as much as 45%, but this will soon to be reduced to just 20% in the next three years.