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Let's look at a few common questions.

Q: What's the rental income needed to qualify for a buy-to-let mortgage?

A: Lenders usually calculate this on a percentage basis. Most will require the rent to be a minimum of 125% of the mortgage repayment (on an interest only basis). This helps explain why, as with mortgaged owner-occupiers, buy-to-let landlords are also very much at the mercy of rising interest rates.

Q: Aside from rental income, do lenders expect any other financial qualifications from buy-to-let landlords?

A: Most lenders will also expect a buy-to-let landlord to have an income other than rental income. This might be from salaried or self-employment. It could also be from a pension or regular share dividends. Whatever the source of the income, a buy-to-let landlord should expect the lender to require proof.

Q: What type of mortgage is best for a buy-to-let landlord?

A: Although repayment mortgages are an option, most buy-to-let landlords opt for interest only mortgages. This requires them to pay off only the interest owing on the loan. The outstanding capital remains outstanding and must be repaid by some other means. Reasons for preferring interest only mortgages include:

1.      The monthly repayments are usually cheaper. The saving frequently amounts to hundreds of pounds per month.
2.      Lower overheads, which, in turn, mean more flexibility to finance other properties. This is a particular consideration for portfolio landlords.
3.      The potential to make tax-efficient savings.
4.      The prospect of repaying the outstanding capital with the eventual proceeds of sale of the property. Obviously, the feasibility of this approach depends on the property at least holding its original value.
5.      Paying less each month is an attractive safety net for tough times. It means a landlord is less likely to find themselves unable to pay the mortgage and, in turn, their tenant is then less likely to find themselves homeless as a result of repossession or a hurried sale.

Q: What are the disadvantages of an interest only mortgage for a buy-to-let landlord?

A: There are a number of potential disadvantages to consider, although not all will apply to every situation. They include:

1.      The possibility that a lender will require a larger deposit. This is because someone borrowing on an interest only basis is considered to be a higher risk than someone taking out a repayment mortgage.
2.      Some lenders will require proof of a repayment plan. This is a more frequent requirement than was once the case, and it's sensible for anyone contemplating a buy-to-let mortgage to draw up such a repayment plan. This might include using pensions, ISAs or, of course, equity - and, especially, equity in other properties. Particularly when sold property prices are stagnating or even falling, relying on the mortgaged property to provide sufficient equity to cover the outstanding capital repayment is not always wise or, indeed, necessarily acceptable to a lender.
3.      Interest repayments will remain high throughout the life of the mortgage. This contrasts with a repayment mortgage, where the interest portion of the repayment falls gradually throughout the life of the mortgage as the capital is slowly repaid.
4.      The buy-to-let landlord will not own their property at the end of the mortgage period. This is because, essentially, an interest only mortgage is rather like paying rent, albeit with the prospect of owing the property provided the capital is repaid.
5.      Inability to repay the outstanding loan at the end of the buy-to-let mortgage period is likely to affect the borrower's credit rating in an adverse way.
6.      As we have already touched upon, falling house values are a real concern for anyone hoping to rely on the sale of a property to repay the outstanding capital element of a buy to let mortgage. Consequently, it's essential that anyone contemplating a buy to let mortgage has a full appreciation of the potential risks they face if falling house values translate into falling sold property prices. It also underlines the importance of cutting a good deal in terms of paying a good price for the property in the first place.
7.      Fewer lenders offer interest only mortgages. This wasn't always the case. Prior to the 2008 financial crisis, even some owner-occupiers used interest only mortgages, while typically relying on hoped-for large capital gains in their property's value when they came to sell. However, 2008 saw the end of many interest only mortgages, with many lenders withdrawing the products altogether or at least reducing the number and scope of their offerings.
8.      The phasing out of the tax advantages of buy to let mortgages has reduced their appeal to many. Prior to 2016, landlords could offset their mortgage interest payments against rental income. Phasing out legislation started to bite in April 2020, and now most buy to let landlords are caught by a 20% tax rate that applies to rental turnover instead of profit. In reality, this has meant little change for landlords who are basic rate taxpayers. However, most higher rate taxpayers now pay more tax than prior to the changes, which may make renting considerably less profitable for them. Furthermore, the tax changes have also pushed some basic rate taxpayers into the higher rate band as a consequence of the requirement to declare income previously used to make mortgage repayments.

Q: Can you combine an interest only mortgage with a repayment mortgage?

A: Potentially, yes. Some lenders offer a product that's a hybrid of the two. This means that as well as repaying the accruing interest, borrowers repay a proportion of the capital owing. At the end of the mortgage term, the borrower will still have some outstanding capital to repay. However, this won't be as much as with a fully interest only mortgage.

Q: Can you switch from an interest only to a repayment mortgage?

A: This is usually easiest to do at the end of a mortgage term - although it is, of course, dependent on finding a lender who will approve a repayment mortgage. Some interest only lenders will also allow borrowers to switch to a repayment mortgage during the life of a mortgage deal. However, this is very situation-specific and will depend on the amount owing, the lender's assessment of the borrower's ability to make repayments, and the lender's own policy.

OneDome is an FCA regulated whole of market mortgage broker. Please contact us for further help and information relating to buy to let mortgages and other mortgage-related enquiries.

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