In the current financial climate of low interest rates and continued stock market volatility, many of us are looking for alternative investment options. Is buy-to-let worth considering?
Before you think about looking around properties, write down the cost of houses you are looking at and the rent you are likely to get. Traditionally buy-to-let lenders wanted rent to cover 125% of the mortgage repayments, although many had relaxed this in the tail-end of the boom years. Most also looked for a 15% deposit, which protects against falling prices.
After the financial crisis, many are now demanding 25% deposits, or even larger, for rates considerably above residential mortgage deals. They generally also require an minimum income level. The best rate buy-to-let mortgages also come with large arrangement fees, which have to be taken into account.
Once you have the mortgage rate sorted - and remember to allow yourself leeway for rate rises in years to come - be clinical in deciding if your investment will work out. What will happen if the property sits empty for a month or two? Will you manage it yourself or employ an agent? How much will the agent charge? Make sure you know how much the mortgage repayments will be and, if it is a tracker, allow for rates to rise.
Existing investors should now be benefiting from lower interest rates, many will have fallen on to their lender's standard variable rate and the slashing of base rate down to 0.5% has done them a favour. This is especially true for many as a lot of buy-to-let deals do not have typical SVRs but a revert rate that tracks the bank rate.
However, new mortgage deals continue to be expensive in comparison to residential deals and it is generally acknowledged that this is a tough time to get into the buy-to-let market.
Property prices have fallen to more affordable levels and those who stick to the tried and tested method of investing for rental returns rather than capital growth are tempted. You will need a big deposit though and should not expect a quick return - be in prepared for the long-haul!
In our opinion, if investors are willing to accept that the value of their property may slide in the short term, and can ensure their property meets the criteria of at least 75% to 85% loan-to-value and returning 125% of monthly mortgage payments, then it can be a good long-term investment. The lending criteria can vary between providers, with some using a fixed percentage rather and a pay rate to caculate acceptable levels.
This may be obvious, but don’t just walk into your bank and building society and ask for a mortgage. There are many other options and consider using a specialist buy-to-let mortgage broker. Remember asking them for information means you are under no obligation to use them, but in our experience advice in the current market conditions can make all the difference.
If you are buying using a mortgage, rent-to-property price yield will not be the return you actually get.
To quickly work out your annual return on investment deduct the annual mortgage cost from the rental income and then work this sum out as a percentage of the deposit you initially put down. For example:
£100,000 property that could rent for £ 500 per month:
£75k interest only mortgage at 5% = £ 3,750
£500 rent x 12 = £6,000
Difference = £ 2,250
Deposit + buying costs = £ 30,000
Annual return = 9%
This is the gross figure and may be subject to income tax, maintenance costs and other landlord expenses. Rent should be the key return for buy-to-let. Most buy-to-let mortgages are done on an interest-only basis, so the amount borrowed will remain the same throughout the term and often repaid on the sale of the property.
If you can get a rental return substantially over the mortgage payments, then once you have built up a good emergency fund, you can start saving or investing any extra cash. Remember though, people rarely buy a home outright and they come with running costs, so mortgage costs, agents fees must be worked out and they will eat into your return.
Once mortgage, costs and tax are taken into account, you will want the rent to build up over time and then potentially be able to use it as a deposit for further investments, or to pay off the mortgage at the end of its term.
This means you will have benefited from the income from rent, paid off the mortgage and hold the property's full capital value. Buy- to-let properties are subject to CGT at either 18% or 28%, on gains above the annual exemption when sold.
As a buy-to-let investor you have the same advantage as a first-time buyer when it comes to negotiating a discount. If you are not reliant on selling a property to buy another, then you are not part of a chain and represent less of a risk of a sale falling through. This is extremly important in the current market. This can be a sizeable asset when negotiating a discount, especially in a tough market such as the one we have now. Make low offers and do not get talked into overpaying.