Buy-to-let mortgages explained for landlords

A buy-to-let mortgage is a loan for a property you rent out rather than live in. Most lenders want a deposit of at least 25 per cent of the purchase price, with sharper pricing once you reach 60 or 65 per cent loan to value. How much you can borrow is driven mainly by the rent, not your salary. Lenders apply an interest cover ratio test, commonly 125 per cent of the mortgage interest for basic-rate taxpayers and 145 per cent for higher-rate taxpayers, calculated at a stressed rate rather than the rate you pay.

On a residential mortgage the lender starts with your income and applies a multiple, then checks your spending. On buy-to-let the starting point is the property. The lender asks a surveyor what the place would realistically let for, then works backwards to a loan the rent can support.

Your personal income still matters, but as a threshold rather than a multiplier. Many lenders want a minimum personal income, often around 25,000 pounds, and most want you to already own your own home. First-time buyers who have never owned anything have a much shorter list of options. Lenders also set minimum and maximum ages, minimum property values and rules about tenant types.

Fees differ too. Buy-to-let arrangement fees are often a percentage of the loan rather than a flat amount. A 2 per cent fee on a 200,000 pound loan is 4,000 pounds, and adding it to the balance means paying interest on it for years.

Plan for 25 per cent as a minimum. On a 200,000 pound property that is 50,000 pounds, and it is not the whole cost. You also need the stamp duty surcharge on additional dwellings, legal fees, a survey, and a float for the first void and any works before a tenant moves in.

Loan to value bands matter more here than most borrowers expect. The gap between a 75 per cent deal and a 60 per cent deal is usually wider than on a residential mortgage, and it compounds because a lower rate also improves your stress test result. If you are close to a band, finding another 5 per cent of the purchase price can be the cheapest thing you do.

The interest cover ratio, or ICR, asks one question: if rates were higher than today, would the rent still comfortably cover the interest? Three inputs decide the answer.

• The stress rate. A notional rate, usually higher than the rate you pay. Around 5.5 per cent is common, though many lenders use a lower stress rate for five-year fixes because you are protected from rate movement for longer.
• The cover percentage. Commonly 125 per cent for a basic-rate taxpayer and 145 per cent for a higher-rate taxpayer. Limited company applications are often assessed at 125 per cent.
• The assessed rent. Not what you hope to get. It is the figure the valuer puts on the report, and if it comes in low the loan shrinks.

Some lenders will also consider top slicing, where surplus personal income bridges a shortfall between the rent and the ICR requirement. It is not universal, so ask rather than assume.

Take a 150,000 pound interest-only loan and assume, purely for illustration, a stress rate of 5.5 per cent.

The stressed annual interest is 150,000 multiplied by 5.5 per cent, which is 8,250 pounds, or 687.50 pounds a month.

A basic-rate taxpayer at 125 per cent needs monthly rent of 687.50 multiplied by 1.25, which is 859 pounds. A higher-rate taxpayer at 145 per cent needs 687.50 multiplied by 1.45, which is 997 pounds. Same property, same loan, roughly 140 pounds a month difference in the rent required.

Now run it the other way, as happens in practice. Suppose the valuer says the property will let for 950 pounds a month.

For a basic-rate taxpayer at 125 per cent, the rent supports 950 divided by 1.25, which is 760 pounds of monthly stressed interest, or 9,120 pounds a year. Divide by the 5.5 per cent stress rate and the maximum loan is about 165,800 pounds.

For a higher-rate taxpayer at 145 per cent, the rent supports 655 pounds a month, or 7,862 pounds a year, which gives a maximum loan of about 143,000 pounds. That is roughly 23,000 pounds less on the same property.

Now change one variable. If the same higher-rate applicant takes a five-year fix and the lender stresses it at 4.5 per cent instead of 5.5 per cent, the 7,862 pounds of annual interest supports about 174,700 pounds. The longer fix has added more than 30,000 pounds of borrowing capacity. This is why so many buy-to-let cases end up on five-year products, and why the length of the fix is a lending decision as much as a rate decision.

Most buy-to-let mortgages are interest only. You pay the interest and the capital balance stays where it is, which keeps the monthly cost down. On the 150,000 pound loan above at an illustrative 5 per cent pay rate, interest only costs 625 pounds a month, where a 25-year repayment version would cost around 877 pounds.

The trade-off is that the debt is still there at the end, and lenders will ask how you intend to repay it. Selling the property is accepted on most buy-to-let lending, unlike residential interest only where it is heavily restricted.

Gross yield is annual rent divided by purchase price. A property bought at 190,000 pounds letting at 950 pounds a month produces 11,400 pounds a year, a gross yield of 6 per cent. That is useful for comparing areas and useless for working out whether you will make money. Net yield is what matters, so subtract the costs that arrive whether or not you have a tenant.

• Letting agent fees, often 10 to 15 per cent of rent plus VAT for full management
• Landlord insurance, which is not the same as ordinary buildings cover
• Maintenance and replacement, for which a rough rule is around 1 per cent of the property value a year
• Annual gas safety checks, electrical inspections and an EPC
• Ground rent and service charge on a leasehold flat
• Void periods, and it is prudent to assume at least a few weeks a year
• Licensing fees where the council requires them, and accountancy fees

On the example above, allow 1,368 pounds for management, 300 pounds for insurance, 1,200 pounds for maintenance and one month of void at 950 pounds. Income falls from 11,400 to about 7,580 pounds before any mortgage interest at all. Deduct interest of 625 pounds a month and you are close to breaking even in cash terms. Build the model before you offer.

Since April 2020, individual landlords cannot deduct mortgage interest from their rental profit. Instead you get a tax credit worth 20 per cent of the interest. For a basic-rate taxpayer the outcome is broadly similar to the old rules. For a higher-rate taxpayer it is not, because the rental income counts towards your total income in full and the relief is capped at the basic rate.

This is the biggest reason limited company ownership has grown, since companies can still deduct finance costs against profit. Which route works better depends on your income and how long you intend to hold, so take advice from an accountant rather than following a rule of thumb.

There is also a stamp duty surcharge on additional dwellings in England and Northern Ireland, with equivalents under Land and Buildings Transaction Tax in Scotland and Land Transaction Tax in Wales. Rates and thresholds change, so check GOV.UK, Revenue Scotland or the Welsh Revenue Authority before you budget.

Most buy-to-let lending is not regulated by the Financial Conduct Authority, because it is treated as a business transaction. There are exceptions. Consumer buy-to-let covers people who did not set out to be landlords, typically because they inherited a property or are letting out a former home, and let-to-buy arrangements can also fall inside regulation. Where the property was or is your home, assume regulation may apply and say so early.

The practical effect is on the protections available to you, not on whether the loan exists. Unregulated does not mean unsafe, but it does mean fewer automatic safeguards.

To compare lenders properly rather than by headline rate, the MortgageMatch directory lists FCA-authorised brokers across the UK. Much buy-to-let lending sits outside FCA regulation, but a qualified broker who places landlord cases will know which lenders stress at what rate, and that is where borrowing capacity is won or lost.